"I skate to where the puck will be, not where it has been" - Wayne Gretzky
Similarly, we feel this analogy applies very well as we consider emerging markets, as
they may offer the combination of strong growth and under discovered opportunities
providing larger upside than developed markets, making them an investment
opportunity well worth considering.
Our timing is fortuitous here, as just one example of the potential in emerging markets,
David Hunt, the CEO of $1T+ asset manager PGIM was featured on Bloomberg TV
stating that while they are currently over weighted in U.S. assets for the short-term, they
are concurrently invested in emerging markets, and in fact if he was looking at the next
5-10 years, growth opportunities will come predominantly from the latter (interview on Bloomberg Markets; The Close, 18 October 2019)
With that said, there is no free lunch in investing, and we must thus weigh some of the
relevant benefits and risks associated with emerging markets. Our prior article covered
the risks in great detail, but as a quick summary of some key points:
Emerging markets often require substantial external investment in both physical and human capital
Emerging markets are often dominated by one major sector, for example energy or mining, rather than being diversified, and thus may be vulnerable to broader market trends outside of their control
While not exclusive to emerging markets, there can be a level of political & social uncertainty that creates risk
Similarly, not exclusive to emerging markets, but another concern is the political and structure reforms to fully unlock growth potential
Financial metrics such as fiscal & monetary policy, debt, currency competitiveness, and liquidity may also be concerns
Liquidity: Perhaps best viewed as the flip side of the information asymmetry benefit accruing to emerging markets, the relative lack of interest (in dollar terms rather than any judgment on underlying value) often means a lack of liquidity compared to more developed markets. For public equities, particularly those which do not have an ADR traded on a more liquid exchange, this can mean having a high bid-ask spread when trying to enter or exit a position; for private investments, this may mean being able to enter a position on advantageous terms due to the relative scarcity of capital, but perhaps lacking the M&A or IPO exit opportunities more available in larger markets
Government: This topic could merit its own lengthy article, but a few high-level points worth considering include, but by no means are limited to:
• Ability of foreign investors to own EM assets, whether IP, (majority) ownership in a business, or land
• Taxation and any repatriation on profits
• The potential for forced partnerships as a condition of market entry
Of course, we would not be here if there were not also many positive factors, which we
believe make emerging markets worthy of consideration at the very least, if not actual
investment when appropriate.
Growth rates: In line with Mr. Gretzky's and Mr. Hunt's quotes in our overview,
emerging markets appear to be "where the puck will be", and thus a very positive factor
in favor of emerging markets that is really at the heart of our analysis, as we want to be
where the best opportunities are and in areas that offer outsized growth potential.
The most recent IMF data further validates this, with emerging market growth at 4.5%
(2018) and forecasted growth of 4.1% and 4.7%, compared to a world growth rate of
3.8% and forecasted growth of 3.2% and 3.5%, and advanced economies growth rate of
2.2% and forecasted growth of 1.9% and 1.7%. Naturally, emerging countries can have
faster growth as they catch up with more developed countries, but with their growth
slowing as they develop (as an analogy, a company with $1MM in revenue needs an
incremental $1MM to double revenue, but one with $5MM needs an incremental $5MM
to accomplish the same) Countries can rapidly transition from the "next big thing" to
being firmly established as leading economies, and the IMF data shows that emerging
markets have been a major driver of overall world economic growth given that advanced
economies have lagged overall growth.
Diversification: One underrated aspect of emerging markets is the diversification
opportunity in a portfolio context, especially for readers in more developed countries.
These readers typically have both their human capital (education, jobs) and financial
capital (investment portfolios, homes, etc.) heavily based in their own country, allowing
investments in emerging markets to provide an attractive diversification opportunity.
Swedrow & Kizer have found a correlation between 0.22-0.29 between emerging
markets and the S&P, and this lack of correlation can help to mitigate risk, as the
different markets will often have different risk factors and growth rates -in fact, they
recommend investors should consider allocating at least 30% to international (both
emerging and developed) markets to better mitigate economic and political risks within the broader portfolio . MSCI estimates that emerging markets currently comprise
approximately 10% of world equity value, creating an interesting opportunity where the
markets are very investable yet with room to grow.
Information asymmetry: As a direct follow up to the MSCI example and similar to
small-cap and micro-cap stocks compared to mid-cap and large-cap stocks, emerging
markets are very investable yet also typically not covered by Wall Street to the depths
that emerging markets are, creating an opportunity for the savvy investor who is able to
appropriately analyze these markets. Another analogy may be the Efficient Markets
Hypothesis (https://www.investopedia.com/articles/basics/04/022004.asp), where large
markets like the S&P or stocks like Apple are analyzed in great depth and approach
strong-form efficiency with fewer arbitrage opportunities, but an emerging market index
or stock not being analyzed much if at all and having signification inefficiency (& thus
higher potential profits even after adjusting for risk). This admittedly will likely take more
upfront work to both become familiar with new markets and gain the right investment
approach for a specific market (I highly recommend Jim Rogers' works as excellent yet
easy-to-read firsthand accounts of an American investor who saw the growth
opportunities abroad and was able to capitalize), but can be very lucrative by finding
opportunities that others do not yet see in markets poised for strong growth.
Broader macroeconomic and social trends: Closely related to the GDP growth rates,
emerging markets tend to have favorable population growth rates. Consumer demand
makes up the largest driver of GDP growth in both developed & emerging economies,
and strong growth rates in emerging markets offer the potential for a larger workforce
and consumer base that can drive outsized GDP growth. From a brief look at the World
Bank data (https://data.worldbank.org/indicator/sp.pop.grow), the world has a
cumulative 1.1% population growth, but with OECD nations, North America, and Asia
Pacific all below 1% (with some regions facing negative growth), and growth instead
coming from Africa, highly indebted countries, and least developed (UN definition)
regions, all with growth over 2%.
In addition to the strong population and GDP growth trends, another major potential
value driver is natural resources. For example, Africa has over 30% of the world's
natural mineral resources, six of the world's fastest growing economies, and major
holdings of oil/natural gas, cotton, gold, and copper. While there is the potential concern
about concentrated economies, especially with 57% of current exports from
hydrocarbons, the sheer size of the proven oil reserves combined with great
demographic trends makes Africa an area of high interest, and one we will examine in
more detail in our next article. (https://www.aljazeera.com/indepth/interactive/2016/10/mapping-africa-natural-
In summary, we believe emerging markets provide a compelling opportunity for
investors to at least consider as part of their portfolios. While there are certainly risks
and concerns perhaps more prevalent than in markets like the S&P 500 or FTSE,
emerging markets offer a blend of strong GDP and population growth, rich natural
resources, and information asymmetry that can add value to a developed market
investor's portfolio, not just from a return perspective but also with reduced risk via
diversification, especially once the investor becomes more knowledgeable about the
emerging market.
The views in this Global Market Outlook report are subject to change at any time based upon market or other conditions and are current as of October 21, 2019. While all material is deemed to be reliable, accuracy and completeness cannot be guaranteed.
Special source/reference credit to the CFA Institute's "Capital Market Expectations"
"Managing Investment Portfolios: A Dynamic Process", and "Asset Allocation and
Related Decisions in Portfolio Management" along with :Larry Swedrow and Jared
Kizer's "The Only Guide to Alternative investments You'll Ever Need" (Chapter 4) for
broad reference points within, and which I strongly recommend for a more detailed
analysis than this overview; analysis author's own.