Putting the 'Emerging' Back in Emerging Markets

Putting the 'Emerging' Back in Emerging Markets

Given that China was the main culprit in the current global market hysterics, many financial advisors and their clients are taking a step back and reevaluating their emerging markets exposure.

As advisors and their clients prepared for their end-of-summer vacations, they awoke on August 19 to a most unpleasant surprise, courtesy of China.

After dealing with months of economic slowdown and then revaluing its currency several weeks ago, the global markets finally felt the need to react to China’s woes, and boy did they react..

Given that China was the main culprit in the current global market hysterics, many financial advisors and their clients are taking a step back and reevaluating their emerging markets (EM) exposure. But while China certainly has its fair share of issues to navigate, don't let that cast a dark cloud over its neighbors.

At a high level, emerging market equities currently trade at a P/E ratio of 12x, which is lower than both the U.S. (19x) and developed international markets (17x). The projected annual GDP growth rate in emerging economies in 2020 also looks attractive with 5.3% growth versus the 1.9% growth in advanced economies. These low valuations and strong growth expectations should alleviate some concerns advisors may have about EMs.

Taking a closer look at the approximately 40 countries classified as emerging, one of the key areas advisors should be focusing on is a more diversified exposure to these countries within their clients’ investment portfolios. Smart advisors understand that the way to opportunity is the road less traveled. As red flags have emerged in established emerging nations such as China, Taiwan and South Korea, advisors should consider the lesser known EMs.

Indonesia, for example, has made great progress over the last 10 – 15 years to strengthen its economy. Not all efforts worked, but many did, and in significant ways the island nation today looks like China circa 1995. Indonesia is the fourth most populous nation in the world and its early-stage maturation is the reason investment opportunities in younger economies exist.

This is not to say advisors should be putting all of their EM eggs into the Indonesia basket, or any single country, for that matter. While accessing smaller, fast-growing EMs are a good first step, strategic diversification across these countries is the second. 

Now, where to look for meaningful opportunity. Companies domiciled in these countries can vary in several ways, but one common characteristic is high exposure to their own local economy. As we’ve seen with China and other major EMs, as these countries have grown and expanded their international footprint, their economies started to have a stronger correlation with established nations. Considering that low correlations is often one of the main reasons for investing in emerging markets, this obviously had some downsides.

Mexico, Malaysia, Thailand and the Philippines are just a few examples of countries with companies that have high exposure to their local economies. How to pinpoint the others is based on the fundamental reason why advisors sought EM investments in the first place – to seize growth opportunities that don’t exist in the developed world.

It’s a fairly straightforward elevator pitch, and those who invested in emerging markets 20 years ago can vouch for the bets they made.

It’s anyone’s guess as to whether the recent market volatility spurred by China is merely a correction or the start of a more painful and sustained downturn. Either way, when we think about capturing that opportunity in the China’s of tomorrow, so to speak, the emerging markets landscape reveals more to get excited about than there is to spoil that vacation.

 

William Hoyt is Head of Research and Portfolio Management at Lattice Strategies

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