I stumbled across this article from the Hartford Courant about investing in emerging markets. I'm not exactly sure if the article is saying that emerging markets will still do well or if now is a time lighten up. If there is a conclusion there I couldn't figure it out.
I have written a lot about emerging markets. The role I think these countries can play is that they tend to have a low correlation to US markets and just a couple of holdings can add a lot of return to a diversified portfolio.
I am benchmarked to the S+P 500 which has no foreign stocks but long time readers know I have a heavy foreign exposure. Since there are no emerging markets in my benchmark it is tough to say how much would be equal weight, overweight or whatever. That being said I think for someone with reasonably normal tolerance for volatility 4% or so might make sense as an equal weight number. These days most clients have 7% or so in emerging markets.
I think picking one of the emerging market ETFs is a great way for some with a low tolerance for volatility to capture exposure. Most clients own one of the ETFs and anywhere from 1-3 individual stocks or perhaps one of the CEFs that invests in India. All of the stocks I own for clients in this area have dividends ranging from healthy to huge.
One catalyst to reduce, not eliminate, exposure to emerging markets would probably be if there was a clear and obvious path for very good things for the US market. As time goes on this analysis evolves.
A big focus here is the low correlation. Although these markets can be volatile, when blended with domestic stocks, the volatility of the overall portfolio can be reduced.
One goal that just about every manager says they have is market beating returns with less volatility. To my way of thinking, doing this successfully means there will always be stocks that are up and there will always be stocks that are down. If I think IBM is the best tech stock out there (just an example, I don't own IBM) and the tech sector is doing poorly I would expect IBM to be down. That does not make the name a sell. Hopefully value is added with the decision to be over, under or equal weight the sector, technology in this example.
So while the next 10% for emerging markets could be in either direction, the role that the asset class plays will not change.
The idea of focusing on the portfolio and not the individual holdings is not easy to do. A common mistake is to focus on the holdings which can lead to selling low, buying high and having a lopsided portfolio.
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7 comments:
...from Jeremy Grantham:
"
Our seven-year forecast for asset classes expects a real return of around 6% from emerging markets. We expect to add three or four points to that from active management for a total return of 9%. We expect the S&P 500, on the other hand, to deliver minus-2%. That's an 11-point spread. And emerging markets have never looked higher-quality than now. Their reserves are fabulous. Their currencies, consequently, all look pretty good. Their growth rates are fabulous. The back page of the Economist lists the 24 emerging countries. If you were to take the gross-domestic-product growth rate of the European Union for the last year and add it to that page, it would rank dead last on a list that includes Egypt, Israel, Turkey and Slovakia. They are all beneficiaries of China, have a terrific fundamental strength at the moment and a good qualitative position. Still in all, they may go bump in the night. But on a three-year basis, I think they are going to hammer the S&P again. "
fyi
george, thanks for the the GMO quote!
My reading of the articles is as follows:
The recent successes of these markets has basis some very real factors including some reforms of their economy. So there is a good chance the basis for long term solid growth is there.
However:
- In the medium term some of the prices have been based on a flow of easy money and this is tightening.
- Some of the distortions that has marred take offs in the past such as overbuilding of certain things etc. are also in play...
so expect a possible medium term correction.
And remember while things are looking better and that there is real, objective evicence to have faith in some of these economies they are still called "developing" for a reason so serious risk is there.
I think the gist is that you have a good chance of making excellant returns if you invest in some of these economies for decades, but the risk has been high in the past, remains high and there are a number of traditional problems that you have to remember such as profits and stock values not rising at the same rate as the economy, while this later problem seems to have been reduced it is one of a number that have to be watched for and put into calculations.
My reading.
- Jen
thanks, Jen!
Roger,
I agree with you that Emerging Markets should be a vital part of any portfolio and now perhaps even "overweighted" whatever that may mean to an individual. You mentioned CEFs for India. What exactlt do you have in mind? I'm not familiar with those and would like more information on them.
Roger,
There is more correlation between S&P 500 and emerging markets than say S&P and small cap intl stocks. Don't get me wrong I love emerging markets for the growth in long term, but there tends to be higher correlation with large US stocks than one might expect.
great comment about correlation. thank you
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