New world not for the faint hearted

While emerging markets offer plenty of potential, investors may be safer if they take an indirect approach.

Emerging markets have underperformed developed markets for four of the past five years. A cluster of markets with so much potential has really been nothing short of disappointing for investors. 

In the past year alone, emerging markets have underperformed their developed counterparts by over 20 per cent (in USD terms).

Despite growth forecasts being revised lower for many emerging market economies, there are investment opportunities. Emerging economies house the majority of the world’s population and the demographics are preferable to the developed world when it comes to growth.

A global investment theme will be franchises, like Nestle and McDonalds, to play the ‘new world’, explained Dr Michael Power recently, global strategist at Investec. There is a thematic with select equity strategists and fund managers preferring multinational companies with exposures to emerging markets, as opposed to the emerging market companies themselves.

Investing in companies with exposure to emerging markets has its merits. It is likely these companies are already profitable in their country of domicile and have experienced management to roll out a geographical expansion into emerging markets.

The latest report from The Organisation for Economic Cooperation and Development explained emerging economies simply can’t grow at the same rate they once did, without resolving some of the major structural issues that they face.

Gross domestic product (GDP) growth has no direct relationship to stock market gains, or losses for that matter, based on the expectation growth prospects are already priced into valuations. So while economic growth in emerging economies is slowing, this has already been allowed for by equity markets.   

As the global economy was stumbling out of the global financial crisis around 2010, the outlook for emerging markets was promising. Developed markets were largely out of favour. However, increasing accommodative monetary policy in the western world essentially altered the riches of equity markets and resulted in emerging markets straggling for the past three years.    

While equity, bond and currency markets across the emerging market regions got jumpy at the mere prospect of tapering in the middle of the year, no credit crunch ensued. However, when tapering does eventuate what happened in May of this year may only be a prelude to the main event. Frankly, it is too difficult to try and predict how financial markets in the emerging will respond but the downside risk has not abated.

From an investment perspective, pockets of emerging markets offer a compelling case. It just may be more practical to take an indirect approach when it comes to investing.