What Emerging Markets Strategy Should Families Adopt?
Overview
The emerging markets have increasingly become a motor of global economic growth as western economies languish. This 2012 Global Investment Forum session examined several key questions. How should families evaluate the relative attractiveness of the emerging markets (BRICs, Next-11)? What portion – or a lower and upper range - of an overall portfolio may families wish to allocate to the emerging markets? Which asset classes afford the best risk-adjusted returns (public vs. private equity funds, direct, fixed income, distressed assets, commodities, etc.)? What is the downside of emerging market investing? How do families hedge the associated risks and how do they gain access to the best investment managers?
Key Take-aways
Macro Context
The average EM GDP growth rate was over 4x that of the developed markets in 2011 and this is set to continue for the foreseeable future. Their 32% average debt-to-GDP ratios are less than half the average of the G7 industrialized economies. Emerging markets have seen $800bn or a rise of almost 3,000% in foreign direct investment since 1995. Their stock markets represent 34% currently of global market capitalization. Most investors are under-allocated to the emerging markets – there is a need for catch-up.
Smaller companies have the potential to deliver substantial capital appreciation as they transition to becoming well-established large-sized companies. Frontier markets (defined as smaller, less developed and less accessible emerging markets countries, but with “investable” equity markets and include those defined as Frontier Markets by the International Finance Corporation as well as included in Frontier Markets indices) represent >$1.5trillion in market capitalization across all regions. Typically, investors should look to allocate 2.5% to frontier markets as part of an overall 15-20% allocation to EMs. A well-diversified mutual fund or other co-mingled vehicle is the preferred route (potentially a hedge fund but only in exceptional circumstances).
Investment Guidelines for Families
- 12-month forward P/E ratios across the span of the emerging markets are currently inexpensive by historical standards (all-time high of 28x in May 1998 vs. 10x in 2012).
- 7.5-12.5% allocation to emerging markets equities is the ‘norm’. On a tactical, short-term basis, it could vary between 10-20% of total asset allocation and 15% is the long-term target for EM equities based on the growing importance of EMs.
- Franklin Templeton currently recommends neutral allocations relative to long-term targets.