Equities

Emerging market assets: Zoom out and re-focus

Emerging markets (EM) are a big part of global markets, yet are typically under-represented in investors’ portfolios. This has led many to ask the best way to build up their strategic allocation to these assets. EM equities and hard, local and corporate emerging market debt (EMD) all have very diff erent characteristics, meaning investor specific risk and return requirements must be taken into account.

09/12/2017

Duncan Lamont

Duncan Lamont

Head of Research and Analytics

Emerging markets (EM) are a big part of global markets, yet are typically under-represented in investors’ portfolios. This has led many to ask the best way to build up their strategic allocation to these assets. EM equities and hard, local and corporate emerging market debt (EMD) all have very different characteristics, meaning investor specific risk and return requirements must be taken into account.

EM equities and local EMD have underperformed substantially over recent years but are well placed to outperform other EM assets handsomely over the medium term. Their outlook also compares favorably with developed market assets. Investors with high required returns are likely to benefit from tilting towards higher equity exposure. For more moderate return objectives, local EMD could improve portfolio efficiency.  A case can also be made for including hard and corporate EMD in an EM portfolio on diversification grounds, despite their being less attractive in isolation.

Introduction

Emerging markets have grown in prominence and now represent around 40% of global GDP (IMF, 2016), twice their level at the turn of the millennium. However, they remain less prominent in global asset markets and even less visible in many investors’ portfolios. For example, emerging market equities are about 11% of the free fl oat-adjusted global equity market (MSCI All Country World Index) whereas many investors hold far less.

The EM asset class category covers a diverse range of countries and sectors with very different underlying fundamental drivers. The risk-return profile varies significantly between equity and debt investments and within debt, local currency, hard currency and corporate debt all exhibit different characteristics and outlook.

There are many different routes to obtaining exposure to emerging markets. For example, an EM equity allocation could be included as part of a global equity portfolio and hard EMD within a global fixed income portfolio. In this paper we take a different approach and address a specific question often raised by investors: what is the most effective way to build a portfolio of emerging market assets? Towards the end we also consider broader portfolio considerations.

Given the diversity of assets available, we do not believe that there is a single best approach to investing in emerging markets and many different portfolios can be considered ‘effi cient’. Investor-specifi c objectives and constraints must be taken into account and a balance struck between the desire for return and the tolerance for volatility and risk of loss.

This paper compares and contrasts some of the fundamental characteristics of the emerging market universe before considering prospective risks and returns for some representative portfolios over a medium- to longterm horizon. We demonstrate that a multi-asset solution should allow investors to pursue returns in a more effi cient manner than by investing in any individual emerging asset class alone. All analysis is in unhedged US dollar terms based on market data as of March 31, 2017.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.