2018 hasn’t been a good year for the emerging markets (EM) investments many of those investing online hope will help drive their returns. The higher volatile equities class has been hit this year by a capital markets flight from risk, seeing the benchmark MSCI emerging markets index slump by around 20% over the year to date.
Those with EM allocations in their investment portfolios may understandably be getting nervous and perhaps even considering cutting their losses. Headquartered and listed on stock exchanges in developing economies that tend to have much higher rates of economic growth than developed markets such as the UK, USA, Western EU, Japan, Australia etc., EM exposure traditionally promises better long term returns, with companies starting from a lower base. However, these markets, which include countries such as China, India, Brazil, Turkey and Argentina, are also characterised by higher volatility.
The good news for investors is that the most recent McKinsey Global Institute research comes to the conclusion that the recent market jitters around EM, most recent and well-publicised the problems facing the economies of Turkey and Argentina, are just that – passing volatility. The research argues that for most emerging markets, the long term trajectory is still very much one of powerful growth.
The report also highlights the ‘outperformers’ among the 71 countries collectively grouped into the ‘emerging markets’ sector by international capital markets. They are China, Hong Kong, Malaysia, Indonesia, South Korea, Singapore and Thailand. All seven met the common achievement of having attained an average of 3.5% annual growth over the half a century up to 2016. Another 11 have more recently gathered a head of steam and shown average yearly economic growth of at least 5% for the 20 years to 2016. They also largely bounced back strongly from the ‘Asian crisis’ of 1997 and weathered the 2008 international financial crisis in resilient fashion.
The best performing emerging market economies largely have two key common denominators – proactive government policy towards capital accumulation, such as mandatory pension plans and have made a tangible effort to improve the efficiency of governance. They also have, on average, twice the number of publically traded companies with revenues that exceed $500 million as their less successful peer nations. There is also more economic mobility with the top companies for profit generation in emerging markets finding it harder to hold onto a dominant position. More than half of the top quintile has changed since 2005, compared to less than 40% in developed economies.
The McKinsey report further highlights the strong record for innovation in successful companies from emerging market economies. The 56% of revenues that is derived from ‘new’ products and services is significantly ahead of peers in more developed markets and investment, as judged on a ratio of capital spending to depreciation, is higher. Crucially, the result of this is also often better returns. Across the 7 outperforming emerging markets, listed companies provided average total returns of 24% between 2014 and 2016 compared to 15% from the best performing 25% of companies in countries with high per capita income.
Levels of corporate debt are, however, higher and can be considered a concern but balanced by lower household debt. While global volatility can hit emerging markets, as we have seen this year, the fundamentals of many of the countries in the group are robust and ‘remain the world’s likeliest source of long-term growth’. So, if you are investing online in EM funds, don’t despair. Sit tight and not only would returns be expected to turn around but there is a significant chance that 5 or 10 years from now they will be one of the best performing parts of your portfolio.