Emerging Markets (EM) equities are regaining interest, after many years of disappointing returns and outperforming their developed-market (DM) counterparts this year. Below are seven factors for investors to consider, who thinking about adding EM.
1. Earnings growth
Earnings growth drives stock returns over the course of time. Companies are expected to grow EPS by 9% this year, followed by 12% growth in 2015, providing a stronger foundation for stock prices.
2. Keep a watch on global events
In a year of unrest in Ukraine, the Middle East, the tapering of the US Federal Reserve’s bond buying, China’s slowing economy, a drought in Brazil and elections in India and Indonesia, EM equities have delivered a respectable 15% return. The lesson: it pays to stay self-controlled in the face of headline risks.
3. The easy EM beta trade is probable behind us
Over the ten days, passive exposure to EM stocks outperformed passive exposure to DM stocks by about 3% annualized, driven by EM’s more rapid relative economic growth, a big profitability and earnings growth benefit and a starting point of depressed stock assessments. Those advantages are more damped today, so the return potential from passive exposure to EM stocks is also probable to be more damped in the years ahead.
4. Volatility is a bigger barrier
With the EM index must be probably counted on stronger headwinds in the next years. So it’s possible that allocations to EM equities will have to work harder to compensate for their far greater volatility. That means you have to find ways to generate meaningfully higher returns than the index and/or employing strategies to reduce volatility.
The fact is that the bar for passive index tracking approaches is higher than that for active strategies that provide much more room for maneuver.
5. Alpha potential remains high
Resourceful stock pickers can exploit mispricings emerging markets, which are creating by developing Markets, because of slower and less transparent flow of information about countries and companies. Well-established factors such as profitability, valuation and price momentum continue to be more productive in driving excess returns in EM than in DM, particularly when combined. Disciplined approaches that target historically dependable return drivers should continue to be rewarded.
6. End of the safety trade
Amid decelerating EM economic growth and lingering postcrisis uncertainties, investors have been paying higher and higher premiums for EM companies with strong current performance, while shunning companies whose earnings growth may come further into the future. The valuation spread between the two has reached an extreme only seen in about 5% of periods over the past 20 years. Index trackers risk being overly concentrated in yesterday’s pricier winners.
7. Vary your exposure with multi-asset strategies and smaller markets
While diversifying risk there are also ways to tap EM return potential. A way are the multi-asset strategies can generate equitylike returns with less volatility by broadening the investment opportunity set to encompass select EM bonds.
Exposure to smaller developing-world markets should also consider by Investors, many of which are growing quickly, yet remain less correlated than the BRICs and are often riper for stock-picking because of greater information inefficiencies. In the near future, markets such as Vietnam, Nigeria, Colombia and Qatar to become more significant constituents in global portfolios.