Mar 24, 201508:23 AMFinancial Perspectives
with Michael Dubis, CFP
The long-term case for emerging markets
(page 1 of 2)
I received this question recently: “Remind me again: why are emerging markets in my portfolio?” A good question. Emerging markets aren’t doing very well lately compared to the U.S. and many other developed markets; it makes sense to wonder why we would want to be invested in them.
I told him I didn’t know, that I must have accidentally hit the wrong button when I was putting the portfolio together … whoops.
Just kidding. There are actually many good reasons.
First of all, my house philosophy is to start with the idea that global diversification is valuable, and the long-term evidence supports that. So investing in emerging markets is a natural addition to this philosophy, even if it’s a small piece of the pie.
Emerging markets make up about 20% of the world’s economies, but they also represent about 80% of the global population. Emerging markets are also relatively young, have little to no entitlement programs weighing on their growth, and are also economically growth-oriented when it comes to both technology and natural resources, among other sectors poised to impact the global economy in the future. These are rather significant observations.
Furthermore, it’s important to reflect on the fact that only about 100 years ago, the United States was considered an emerging market but became the world’s leading developed market, so ignoring emerging markets could affect your long-term returns and cause you to miss out on the next big thing. Exposure to that potential value should be appealing.
And being exposed to emerging markets was certainly beneficial in the “lost decade” of 2000-10, during which they were among the best asset classes to own and carried globally diversified portfolios. In fact, in six of the past 12 decades, emerging markets outperformed developed countries; in other words, in 50% of the past 12 decades, emerging markets have outperformed developed countries, and in 50% they have underperformed.
Looking at it that way, we really should also ask ourselves, “Why do we invest in developed markets?” They encounter roughly the same decade-by-decade underperformance as emerging markets. We don’t ask this because we have short-term memories, and U.S. investors are usually U.S.-centric in their portfolios because “that’s what we know.”
However, investing in emerging markets does come with a large number of risks (although at times, these risks apply to developed markets, too): political, volatility, liquidity, and currency, to name a few. Furthermore, many emerging markets struggle with the development of an overall economic and securities infrastructure. Meanwhile, some emerging markets do not align well with investor interests. This is why you often see such uneven performance among emerging economies, and it’s why emerging markets are scarcely represented in many traditional portfolios. Investing in them is simply not for the faint of heart.