The long-term case for investing in the emerging markets is predicated on a number of factors.
The main one is demographic change and population growth.
Add in structural reform, and over time it seems clear that emerging economies will increase their share of global GDP significantly.
With a long enough time horizon, investors should be confident that these secular drivers will deliver a healthy return to investment assets focused on the regions.
However, as the economist John Maynard Keynes noted, “in the long run, we are all dead”. He went on to say that “economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us that when the storm is long past, the ocean is flat again”.
Therefore, saying that exposure to emerging markets will pay off with a long enough time horizon is a reasonably easy, though possibly useless, thing to say set against the practicalities of managing both investments and expectations.
What to say about them now?
Well first, that it is too simplistic to lump all so-called emerging markets together. Most are subject to very different influences – for example, factors important to Mexico are of far lesser significance to China. The commodity cycle is of crucial importance to some, while irrelevant to others.
US dollar strength also has different, and sometimes opposite, economic effects depending on the individual country or region.
What one can say with confidence is that their less well-developed capital markets, less defined corporate governance and often – though by no means always – less stable government, combine to make investing in newer economies rather more risky and volatile than in more developed markets. This insight regularly seems to take the market by surprise.
Idiosyncratic geopolitical risk has risen through 2014. Probably still most pertinent remains the Russia/Ukraine problems and the potential issues around energy supply into the region and further into Europe.
There remains risk that any disruption could add another impediment to European recovery and therefore impact global demand and GDP. Ebola remains an outside risk at the moment, with reports from the World Health Organisation not very encouraging.
The next question is whether valuations already reflect the risks.
For the most part, valuations are reasonable on an absolute basis and cheap on a relative basis – versus developed markets and particularly the US.
At this point, if the US and UK can continue to deliver growth, and Europe flirts with, but does not fall into recession, then it can be suggested that emerging market equities are good value and we are not entering a global equity bear market – where a sell off would be felt disproportionately.
In order to feel more comfortable, you can be a little more selective.
Countries where government takes structural reform seriously should benefit, while commodity-focused, unreformed countries will continue to carry disproportionate risks.
