Why Emerging Markets Funds Are Set To Bounce Back After A Decade In The Doldrums

Published On: August 25, 2020Categories: Stocks & Shares2.7 min read

Over the past 10 years, emerging markets funds which invest in companies listed on stock exchanges in less developed economies, have performed terribly. Over the past decade, the MSCI emerging markets index has returned a mere 9% compared to 200% from U.S. stock markets and 134% for investors in Japan’s Tokyo Stock Exchange.

But more recently, emerging markets have been doing better, up 0.2% since February over the course of the Covid-19 pandemic. Only U.S. stocks and developed Asian markets have done better, up 0.7% and 2.6% respectively. Emerging markets have outperformed the UK, Europe and Japan despite being dragged down by a massive 25% drop in the value of Latin American stock markets.

Many analysts now believe a weakening dollar, a trend that could remain in place for some time as a result of the Fed’s massive quantitative easing policy, could see emerging markets perform well for an extended period. Emerging markets tend to benefit from a weaker dollar because government and corporate debt is mainly dollar denominated, making it less expensive to service. That leaves more money left over to be invested.

Additionally, when the dollar is falling in value, U.S. capital is more likely to be invested overseas. The Dixie index, which measures the strength of the dollar relative to a basket of other leading international currencies, is currently at its lowest level since 2018 and looks to be heading lower.

Emerging markets stocks also look good value for money at the moment, especially compared to those listed on Wall Street. Emerging markets are currently around 65% cheaper than the USA. Dr Mark Mobius, manager of the Mobius investment trust and an emerging markets veteran commented for The Times:

“The current valuation gap is the largest I have witnessed. These economies account for one third of the world’s population and their increasing spending will act as an engine for future global growth.”

Emerging market economies have evolved over the decades. Back in the 1980s and 1990s, these economies mainly relied on commodities exports and low value manufacturing. But fast forward to 2020 and internal consumer purchasing power has improved considerably, especially in China. Overall the reliance on exports has declined.

China has also successfully developed its own tech giants such as Alibaba. Business models based on digital platform services don’t require particularly heavy capital investment, making them both very profitable and scalable. As the digital economy develops in emerging economies, we can expect more valuable, profitable technology companies driving returns, as has been the case in the USA over recent years.

UK investors don’t on average, have a great deal of exposure to emerging markets. Templeton Emerging Markets Investment Trust’s Chetan Sehgal, the trust’s lead manager, says that UK-based investors hold only 10% of their capital in emerging markets. 76% is invested in developed markets and half of that in the UK. That, says Mr Sehgal, means British investors are missing out on good opportunities.

But investing in emerging markets doesn’t come without risk. They tend to be more volatile than developed markets and are typically more exposed to geo-political events, such as the growing tensions between the US and China.

Falling commodity prices are also a risk that should be kept an eye on. Copper prices are considered a strong proxy for emerging markets performance. The MSCI emerging markets index and copper prices have shown very tight correlation for 28 years now, which indicates falling copper prices are a reliable canary in the coal mine when it comes to assessing short term emerging markets risk.

About the Author: Jonathan Adams

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