Emerging Markets Investing – why you should care?
The Australian investors have a very strong home bias when it comes to investing in stocks. This means we are missing out on good returns from high growth markets. Missing out on the related diversification benefits. One area to consider when building a portfolio is Emerging Markets investing.
What are Emerging Markets?
The name sounds scary and super risky. But when you dig into it, it isn’t that scary. The general definition of Emerging Markets is everything that isn’t Developed Markets (ie US, Australia, Western Europe, Japan). Emerging Markets include the likes of Brazil, Russia, India, China, South Africa, etc.
Why you should care about Emerging Markets?
Apart from diversifying out of your home bias there are two key reasons you should care.
Emerging Markets is simply too large to ignore now. Just the top 4 Emerging Markets countries account for 18.1% of global market cap. This has grown from 3.4% share in 2005. By not having your money in such a large part of the global market, you are at risk of FOMO.
Another way to look at the size of these markets is to consider their GDP contribution to the world. The chart below shows the forecast GDP contribution of key Emerging Markets countries. You can see the BRIC countries vs Japan and other key Developed Markets.
Source: Data from World Bank and The World in 2050, PriceWaterhouseCoopers 2008
Emerging Markets offer growth to bump up your portfolio’s return. Coming off a lower base, Emerging Markets generally achieve higher average returns compared to Developed Markets. In the last 20 years, Emerging Markets returned 10.8% per year (on average), higher than the ASX at 10.3% and Developed Markets average of 8.3%.
Based on long term economic outlook, there is a good case that Emerging Markets will continue to out grow Developed Markets in the long term.
Careful with risks
Of course, when there are higher returns, there are more risks. Emerging Markets lost money (experienced negative returns) in 8 out of the last 20 years. In comparison, the ASX was negative in 5 out of 20 years. But when properly included in a portfolio of negatively correlated assets, you can smooth out that risk.
The chart above shows the # of years each market recorded returns within a specific range between 1996 to 2015. For example, the ASX experience 1 year of less than -20% return in the last 20 years.
When investing in Emerging Markets, it makes a lot of sense to invest in index funds (or ETFs). With less developed markets, there are greater corporate governance issues. This drives up the risk of any one specific company. This makes stock picking even harder! These markets are also more inefficient. So there will be higher bid/ask spreads when you buy direct shares.
ETFs to enable Emerging Markets investing
If you are interested in looking at Emerging Market ETFs in Australia, we are lucky to have a few on offer. This is not an exhaustive list, but they include the ETFs with >50% exposure to Emerging Markets:
+ iShares BRIC - IBK
+ iShares Taiwan - ITW
+ iShares South Korea - IKO
+ iShares China 25 - IZZ
+ iShares Emerging Markets - IEM
+ Market Vectors China 300 - CETF
+ SPDR Emerging Markets - WEMG
+ UBS Asia 50 - UBP
+ Vanguard Asia Emerging Markets - VAE
+ Vanguard Emerging Market - VGE
Note: Reference to the returns of Emerging Markets reflect the MSCI Emerging Markets Index; Developed Markets reflect MSCI World Index. All returns are adjusted to AUD, in total returns, pre-tax.