Emerging market equities, shares in companies located in less developed regions of the world, have been one of the biggest success stories so far in 2017.
In the year to date (30 December to 6 October 2017), the MSCI Emerging Markets index, which captures the performance of large and medium-sized companies across 24 emerging markets countries, has risen by 23% in sterling terms. This compares to 10% from the MSCI World index (large and medium-sized companies in 23 developed market countries) and 9% from the S&P 500 index (large US companies), according to FE Analytics.
Emerging markets have enjoyed a resurgence since the oil price bottomed during the first quarter of 2016. This followed a challenging few years when they lagged behind their developed counterparts, as lower commodity prices and fears of a Chinese slowdown weighed on performance.
Today, it appears to be a different story. Emerging markets have benefited from an improved economic backdrop, earnings growth and consumer trends.
Emerging economies are by no means homogenous, so there will be exceptions. Nevertheless, it is fair to say that investors in funds that specialise in global emerging markets are likely to be happy with returns over the past 18 months, with the average fund in the Investment Association’s global emerging markets sector up 49% from 1 April 2016 to 6 October 2017, according to FE Analytics.
Can this momentum continue? Analysts at Goldman Sachs Asset Management believe it can, with a little help from millennials. How the millennial consumer thinks and acts is likely to have a profound impact on emerging market growth over the coming years. For example, e-commerce penetration in China has surpassed the US – millennials typically making 40%-plus of purchases online*.
Some emerging markets offer superior growth prospects in comparison to developed markets. For example, India has great demographics, an entrepreneurial society and political stability under prime minister Narendra Modi. Unfortunately, valuations are starting to look pricey, so it isn’t a screaming buy right now. Nevertheless, it should represent a good long-term allocation – if you can lock your money away for at least fi ve to 10 years.
My enthusiasm doesn’t extend to Brazil, where president Michel Temer faces corruption allegations. This creates the potential for further economic instability, following the impeachment of former president Dilma Rousseff last year.
I view China as a mixed bag. Question marks remain over the sustainability of debt levels and the potential impact of an economic slowdown. On the other hand, there are some fantastic companies in China, so stock selection is key.
On various metrics, emerging market stocks appear fair value right now; a re-rating has accompanied the fantastic run these markets have had over the past year.
I suggest backing an active fund manager rather than an index tracker fund. This is because savvy stock pickers can buy into exciting companies (hopefully, at the right price), avoiding state-owned enterprises, where investment prospects are less favourable and debt levels can be high.
Julian Mayo and Mark Bickford-Smith, who manage the Charlemagne Magna Emerging Markets Dividend fund, are talented stock pickers. They focus on companies with high dividends or dividend growth potential. [Moneywise says: Note that this fund has a relatively high ongoing annual charge of 1.42%.]
I also like M&G Global Emerging Markets’ value bias. Manager Matthew Vaight identifies stocks where change is happening that hasn’t been appreciated by other investors. He is happy to hold these stocks long term. [Moneywise says: This fund’s ongoing annual charge is 0.98%]
However, there are risks: these include geo-politics (not least the growing tensions between the US and North Korea), US protectionism and the impact of Federal Reserve monetary policy tightening.
Emerging market equities represent a good long-term investment, given the exciting growth prospect – but try to stay calm if volatility returns.
*Source: Goldman Sachs Global Investment Research, ‘The Asian Consumer: Chinese Millennials’, September 2015 Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time.
Darius McDermott is managing director at Chelsea Financial Services and FundCalibre.