Returns are bouncing back but investors should be prepared for the downs as well as the ups
After an appalling 2018, emerging markets surprised investors with a strong start to 2019. The Chinese share market, for example, jumped 29% over the first quarter, recording its best performance in more than four years. The rally was sparked by the Federal Reserve’s backflip on raising interest rates. China topped all sharemarkets, beating Colombia (up 19% for the quarter), Greece (18%) and the UK (16%).
At a time of low returns, investors are taking a renewed interest in emerging markets. Some funds are bouncing back into the black with, for example, State Street’s SPDR S&P Emerging Markets exchange traded fund up 9.32% over the three months to the end of March 2019.
But on the whole developed markets are still ahead – the MSCI World Index is up 4.6% over the year to March, compared with -7.4% for emerging market equities. Emerging markets had two stellar years before that when they comfortably outperformed by 7%pa.
The long-term history of emerging markets often reflects either remarkable outperformance or underperformance, compared with developed markets.
The questions for investors are: does this represent an opportunity and, if it is a good time to add emerging market equity exposure, what is the best way to invest?
One way to look at emerging markets is that they offer attractive valuations – particularly after negative returns last year – in a world full of expensive sharemarkets.
“The valuations are fairly cheap,” says Geoffrey Wong, head of emerging markets and Asia Pacific equities at UBS. “In fact, they are trading at 10% above what we would consider to be crisis levels.”
The forward price-earnings valuation for the MSCI Emerging Markets Index is 11.8. This compares with 15.3 for the MSCI World Index and 16.8 for the US. Emerging markets are usually cheaper, so a valuation discount is not unusual.
But before you dive in, there is a lot to weigh. “Emerging markets are for investors looking
for higher rewards but also higher risks,” says Sarah Shaw, a global investment manager and chief investment officer at 4D Infrastructure.
The politics of emerging countries are often more unstable, with higher levels of corruption than in developed countries. Many emerging markets are dominated by commodity-producing companies, which tend to go through long highs and lows.
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