By Jeff Shen
It may be hard to believe, given the flight from emerging markets this spring and the way EM equities have underperformed developed market stocks for the past three years. But investors who stayed the course in EM equities over the last decade have been well rewarded.
The benchmark Morgan Stanley Capital International (MSCI) Emerging Markets Equity Index returned 13.1% annually in the 10 years ended July 31, 2013. EM debt investors did well, too. In the same period, the JP Morgan Emerging Markets Bond Index returned 9.40%.
What a ride it has been, though. Even before the spring selloff, EM equities were well below their 2007 high. Meanwhile, EM debt made most of its gains in the post-crisis period. Look closer and the picture grows even more complicated, and the variances – among issuers, countries and currencies – get even wider, especially in the current climate.
How much damage a strengthening dollar will inflict on emerging markets this time around, and how it will be distributed, is still to be seen. But it has already put a few more dents in the approaches and methodologies that many institutions use to invest in them. The fundamental attraction of emerging markets only seems to grow stronger: an outsize share of global growth, often in a context of local macro stability. Meanwhile, the challenge of achieving sturdier, more strategic exposures to that growth only seems to get harder.
Of course, a strategic allocation wasn’t even the objective of most institutions in the early days of EM investing. Back when these markets were actually emerging, allocations tended to be tactical and smaller, and investment choices were fewer. Volatility was an even bigger problem than it is now. But low correlations with developed markets and the chance to enjoy rapid growth in a corner of the portfolio made the effort worthwhile.
Today’s investors face a much bigger and more complex landscape that also demands more attention as an investment arena – the inevitable result of emerging markets’ outgrowing the ‘emerging’ label and becoming a more integral part of the global economy. Issuance of both equity and debt has burgeoned, and local currency debt markets have become an important investment option. A myriad of choices both between and within asset classes now exists, and tools such as the ability to sell short have become much more available. Correlations with developed markets, meanwhile, have gotten far higher.
As a result, even investors who were ahead of the curve in acknowledging the merits of emerging markets in the past, and who now consider themselves sufficiently allocated to the asset class, may need to rethink their approach to both equity and debt markets. For those who have not fully embraced emerging markets – and clearly there are many, for whether one uses share of world GDP, global growth, or the world supply of financial assets as a benchmark, most institutions are still under-allocated – the recent pullback in asset prices provides an opportune moment to revisit the reasons for that under-allocation and to examine whether they can be overcome.
And as emerging markets continue on their trajectory of increasing importance, integration and complexity, all investors may want to consider a strategy that is more holistic than the traditional piecemeal approach. Multi-asset solutions, which are designed to provide exposure to the full spectrum of emerging assets in a single, risk-controlled framework, may prove to be increasingly useful tools for navigating the challenges and complexities that lie ahead.
Jeff Shen is head of BlackRock’s emerging markets and co-head of investments for BlackRock’s scientific active equity
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