Emerging into profit or loss? Opinions are split about prospects for Brazil, China and India
Saturday 16 June 2012
No one can argue that the emerging economies have been the best place to invest over the past decade, with those companies exposed to the region enjoying bumper profits on the back of rapid urbanisation as well as economic expansion.
A look at the statistics illustrate the point, with average funds in both the IMA China/Greater China and IMA Global Emerging Markets sectors delivering 202.15 per cent and 191.43 per cent respectively, according to Morningstar data for the 10 years to 4 June 2012.
These are particularly impressive when you consider that the average fund in the IMA UK All Companies sector is only up by a modest 51.65 per cent, while IMA North America has risen by a miserly 27.61 per cent and IMA Japan enjoyed a meagre uplift of 2.21 per cent.
Some emerging market-related funds have done substantially better than the pack. Aberdeen Emerging Markets, for example, has returned 354.61 per cent, while First State Global Emerging Markets and Baring Hong Kong China are both up by more than 280 per cent.
There are several reasons why such funds have performed so well over the past decade, according to Andrew Merricks, head of investments at Skerritt Consultants, one being exposure to countries that have the natural resources needed by the rest of the world.
"The income received from selling these commodities has seeped out into the rest of the region and has helped it develop," he explained.
"In addition, these emerging economies haven't struggled with the same debt problems that have affected the more developed nations."
But the question is whether these regions are still worthy of investors' attention and money. Are the growth rates sustainable or is it better to start putting money into Western economies in the hope they will recover strongly?
It's a point that's dividing fund managers and independent financial advisers.
What is the idea behind investing in emerging markets?
The idea is to invest in companies, markets and regions which are growing rapidly in the hope of making higher returns than would be possible by putting money into the more developed areas of the world.
This exposure can be by investing into a country-specific fund – such as one focusing on China – or through a global emerging markets fund that will have a broader, more diversified remit and invest across a number of regions and marketplaces.
However, by their very nature these investments will be in relatively unpredictable companies and countries, so the potential for losing money will also be considerably higher – as people have found out who have been burnt in the past by crises in Latin America and Asia.
The arguments in favour of investing now
Despite the risks, Geoff Penrice, an independent financial adviser with Honister Partners, is convinced that emerging markets remain the best, long-term growth story.
He sees the main positive for investors having exposure as the potential to enjoy higher returns.
"There is no doubt that future, global economic growth will be driven by emerging economies," he said.
"In the developed economies of the UK, Europe and Japan, we will see long-term growth rates of 2 to 3 per cent, whereas in developing economies, such as China, India, and Brazil, we expect 7 to 9 per cent."
Hugh Young, managing director of Aberdeen Asset Management Asia and manager of Aberdeen New Dawn Investment Trust, pointed out that the International Monetary Fund estimates Asia's economy will be larger than that of the United States and European Union combined by 2030.
"The region may face short-term challenges such as the euro crisis and the transition from export-led economies to ones promoting domestic consumption," he said.
"Over the longer term, we remain optimistic about Asia's prospects, which are undiminished despite these concerns.
Studies back up this stance. Although China's economic performance over the last three decades has been impressive – with annual growth averaging 10 per cent and more than 500 million people lifted out of poverty – it's a trend that's likely to continue, according to the World Bank's China: 2030 report.
"Even if growth moderates, China is likely to become a high-income economy and the world's largest economy before 2030, notwithstanding the fact that its per capita income would still be a fraction of the average in advanced economies," it states.
The arguments against investing now
Robin McDonald and Marcus Brookes, the co-heads of Cazenove's multimanager operations, have their reservations about putting money into emerging markets.
While acknowledging the fantastic returns generated by these regions, they believe investors need to be very cautious about investing any further cash.
"We are recommending investors be more cautious because the next decade is likely to be different in terms of winners and losers," said Mr McDonald. "When this massive change takes place – and we suggest it has already started – ructions are likely to be felt across stock markets and the global economy."
The two managers are keen to draw people's attention to the fact that they shouldn't necessarily be looking to position their portfolios on the basis of extrapolating what has happened in the past.
"It's time for investors to reappraise their very strongly held beliefs about emerging markets," added Mr Brookes. "They need to take a step back, double-check the facts, and test their portfolios for something they believe shouldn't happen – the US dollar getting stronger and China weakness."
That's not to say developing economies are going to grow at a slower rate than the West, but that there are significant risks to the whole story.
"The fact is that most growth over the last decade has been from emerging markets and all expectations for future growth are centred on them," said Mr McDonald.
"As a result, not only are there huge risks to these growth stories but you also pay a very high price to participate in them."
So where does this leave the average investor?
Emerging-market economies are much healthier than their Western counterparts and have the potential to perform well due to rising demand for goods and services from domestic consumers, according to Patrick Connolly at AWD Chase de Vere.
"Emerging-market funds would have once been considered too high risk for many investors, but that's no longer the case," he said.
"As emerging-market equities have become a mainstream asset class, all except the most cautious investors – who should stick with cash or just a small exposure to risk assets – should have part of their portfolio invested in emerging markets."
However, potential investors should still be aware that investing in these regions remains very high risk with performances likely to be extremely volatile.
As a result they would be well advised to only have a relatively small proportion of their assets invested in such areas.
"The amount you should invest in emerging markets depends on your financial objectives, circumstances and attitude to risk," he said. "Typically, an investor should hold between five and 10 per cent, though the most aggressive investors could hold up to 20 per cent."
They also need investment horizons of at least five to 10 years, said Darius McDermott, managing director of Chelsea Financial Services.
"If investors can see through the volatility then they could get handsome returns, but these are not areas for low-risk investors," he said. "You need to be looking at the medium to long term because some of the potential in emerging markets will take a while to come through given the macro background in the developed areas of the world."
How to get exposure
AWD Chase de Vere prefers to get access to broad-based emerging markets funds from established managers such as JPM Emerging Markets, First State Global Emerging Market Leaders and Schroder Global Emerging Markets
"Another way to access the growth story in the emerging markets is through Western companies that are doing business in the region," said Mr Connolly. "A number of funds, such as M&G Global Basics and AXA UK Select Opportunities, are positioned to try and benefit from this."
Geoff Penrice at Honister Partners, believes the key to reducing the risks involved in investing in emerging markets is to diversify as widely as possible, and suggested the Dimensional Emerging Market Core Equity fund is worth a look.
"It does not pick individual equities as stock selection is a strategy that is expensive to administer, fraught with risk and very hard to do successfully on a consistent basis," he said. "Instead, it invests across the whole of the emerging market arena which gives the fund incredible diversity and reduces risk. It does not slavishly track the markets but will spread widely and include investments into small and value shares to increase the long-term potential for returns."
Whichever route is chosen, it's essential that investors put their faith in experienced fund managers, according to Mr McDermott.
"They also want those that can do well in both good times and difficult periods," he said.
"The two stand-out candidates are Aberdeen and First State that have good, long-term track records and have outperformed in tough times."
Best-performing sectors over the past decade
1. IMA China/Greater China 202.15%
2. IMA Global Emerging Mkts 191.43%
3. IMA Specialist 161.93%
4. IMA Asia Pacific ex-Japan 151.33%
5. IMA European Smaller Cos 131.30%
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