Are emerging markets developing into a portfolio powerhouse?

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US markets have generally reacted well to President Trump’s election win and first couple of weeks in office, but there are concerns that his protectionist policies may have a negative impact, in particular on emerging markets.

In our Autumn Investment Outlook, we talked about how having exposure to emerging markets is a useful diversifier for your portfolio. That still holds true in the long term, and indeed two emerging markets – Brazil and Russia – were the best performers last year (click here for our emerging markets infographic to find out more about the major emerging market economies), which drove the performance you can see in the table below. The table below shows the annual returns from each of the main Investment Association (IA) sectors, in descending order of performance.

Are emerging markets developing into a portfolio powerhouse?
Source: Morningstar. IA sector returns in GBP. Past performance is not a reliable indicator of future returns

There is a school of thought that developed markets and emerging markets have decoupled in terms of how they behave, and there is often a lack of correlation between returns from them. However that is not always the case, as can be seen from the fact emerging markets and North America were the top two performing markets in 2016.

Firmer commodity prices and evidence of structural reform in some countries potentially underpin the emerging markets equities investment case. As investors continue to ‘hunt for yield’ in this low interest rate environment, they continue to offer some attractive yields within both the equity and fixed income spaces.

There are yet further reasons to consider emerging markets.

Demographics – the numbers don’t lie.

Over 80% of the world’s population live in emerging market countries. In considering this statistic, JP Morgan notes that these countries arguably “…house the consumers of the future”, and represent an asset class that is growing considerably faster than developed markets. Within its Luxury Brands fund, Julius Baer recognises that the emerging middle class in many emerging markets is the growth driver for a number of prestige brands. Fund manager Scilla Huang Sun cites China as an example, anticipating organic growth in luxury brand sales of at least 5% for 2016.

Less developed markets mean greater opportunity.

A distinguishing feature of emerging markets is their less mature stock markets. This greater potential for pricing inefficiencies could allow for more attractive valuations. M&G feels that emerging markets equity valuations are currently attractive as they are not pricing in enhanced returns achievable by more effective capital allocation. Schroders’ Asian Income fund employs a ‘bottom-up’ approach to investing (focusing on individual stock analysis) to exploit perceived Asian market inefficiencies. Stock selection based on comprehensive in-house research drives their investment process.

In the search for yield, EM can augment portfolio returns.

With bank interest rates and fixed income yields at historical lows, the investment case for emerging markets has strengthened in recent times. At M&G, fund manager Matthew Vaight has observed the improving capital management of corporations in this sector with great interest.

In considering this trend, Vaight states that companies “…now often appear to be prioritising profits over growth for growth’s sake”. Companies within the emerging markets asset class have a strong dividend history and JP Morgan’s Omar Negyal recognises that, even in an economic downturn, this income stream persists in many cases. Furthermore, these regular dividend pay outs can help alleviate concerns over the greater risk profile of emerging markets assets.

Richard Sennitt, manager of Schroder Asian Income, points towards the diversification of income streams as further evidence of emerging markets assets’ appeal. In terms of total dividends paid, 47 stocks in Asia account for the top 50% of dividends as opposed to only eight companies in the UK.

Sectors to watch in 2017

As manager of M&G’s Global Emerging Markets fund, Vaight is looking towards opportunities in technology and financials. He notes that although selectivity is a key consideration, “…within financials… the combination of cheap valuations and improving credit cycles is an attractive prospect.” Negyal is keen on telecoms and consumer companies and is overweight in both sectors.

From a country perspective, Taiwan features heavily within his Emerging Markets Income fund due to the “…robust dividend culture…and dividend policies which are minority investor friendly.” Richard Sennett is also paying close attention to the telecoms sector which is benefitting from increased data usage.  Additionally, some Hong Kong property companies have piqued Sennett’s interest as valuations indicate they are trading at significant discounts

Of course, it is worth remembering that the US could ultimately cast a shadow over investor optimism in emerging markets for 2017. Trump’s protectionist policies, a stronger US dollar and further interest rate hikes could all weigh heavily on their returns this year.

There is still a lot to be excited about for the emerging markets investor in 2017. Although these investments can be comparatively riskier when viewed in isolation, they should always be assessed within the context of a balanced portfolio. Their lower levels of correlation with developed markets can increase diversification and reduce overall risk.

 

Find out more about each of the funds mentioned in this article:

Julius Baer Luxury Brands:

View report

Schroder Asian Income:

View report

M&G Global Emerging Markets:

View report

 

The views expressed by the fund managers are their own and do not represent the views of TD Direct Investing.

Investing in Emerging Market Investments involve different risks from the UK markets, in many cases the risks are greater.

The value of international investments are affected by currency fluctuations which might reduce their value in sterling.

Remember that each fund is unique and hence exposed to different levels of risk. Some are relatively low risk, whilst others can be very risky and those will only be appropriate for more sophisticated investors.

You should also read the Key Investor Information Document (KIID) about the fund(s) you are considering before investing.

Neither industry information nor third party recommendations reflect the opinion of TD Direct Investing, and publication on this website does not constitute an endorsement. Industry news is provided for information purposes only. Occasionally, an opinion about whether to buy a specific investment may be provided by third parties. The content in Investing News is not a personal recommendation, and is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives.

Services offered on an execution-only basis. If you have any doubt over the suitability of a particular investment for you or if you are uncertain how the pensions rules affect your personal circumstances then you should seek independent financial advice.

Past performance is not a reliable indicator of future results.

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