By: Blake Holman, Trust Portfolio Manager
What are “Emerging Markets?”
In order to understand emerging markets and their role in your portfolio, it may help to describe exactly which countries comprise the “emerging market” space.
China, India, Russia, Brazil, Mexico, Philippines, Taiwan, South Africa, and South Korea are among the largest components of the index. These countries all have certain traits in common, most notably, they tend to be destinations for offshored and outsourced manufacturing. Emerging countries are expected to experience faster economic growth than their developed market peers since they tend to have younger populations and accelerated GDP expansion compared to what we see in more mature economies like the U.S. or the Eurozone. Companies with direct exposure to countries with high growth rates have historically experienced high growth rates themselves.
Emerging market companies often trade at higher multiples than a typical S&P 500 company, so they can be considered “expensive” when analyzed using metrics like Price-to-Earnings and Price-to-Sales ratios. These higher multiples are analogous to the US tech industry. We pay more for their present earnings under the belief that their high growth rates will make our entry price appear relatively cheap in the future.
These benefits are not without their own unique costs. Risks involved in investing in Emerging Market Equities:
- They are subject to greater volatility and a differentiated risk profile when compared to their developed market peers
- Their capital markets tend to be less open (compared to developed market), while corporate governance standards and transparency can be lacking
- Namely, there is greater legal risk posed by varying degrees of property protections, as well as risk stemming from geopolitical trends – think Russia’s annexation of Crimea and sanctions which have stymied their economic expansion
Place in Portfolios
It is important to be mindful that achieving high returns necessitates increasing the risk profile of an investment portfolio.
Emerging market equities are just one of many sources of heightened risk/reward associated with a broadly diversified investment.
The graph on the left is T. Rowe Price’s 2021 Five-Year Capital Market Assumptions (key word being assumptions). As you can see, they expect Emerging Market Equities (EM Equity) to return 7.2% annually over the next five-years. In fact, they expect EM Equity to lead all asset classes over this time frame, besting Developing Market Equities (DM Equity) expected return of 5.3%. Again, this should be the case given the risks in Emerging Markets.
Please consult with your tax, legal, and financial professional before making any personal investment decisions. None of this information is intended to constitute investment advice.