How have emerging markets portfolio allocations evolved in recent years, and how could investors start to realise further opportunities in this area?
Emerging markets (EM) have long been a source of opportunity for investors – but at a potential cost. However, the underlying level of risk - and reward – within countries, varies greatly; and investors are increasingly looking to structure their portfolios to reflect this.
Ask any active EM equity manager and they’ll tell you it’s not a homogenous asset class. Multi-asset investors are starting to recognise this, and as the asset class has become more embedded in portfolio allocations, they want more tools at their disposal to reflect this lack of homogeneity. The reality has always been that countries within the EM universe have grown at different speeds but the lack of information and transparency for some countries has dissuaded some multi-asset investors from single-country exposures. It follows that investors have been looking at ways to minimise exposure to some countries without giving up the investment opportunity in faster-growing but less economically developed nations. The UK’s Investment Association has already introduced China, India and Latin American equity sectors, reflecting the broader move by investors into these regions.
For some time now the multi-asset team at CLAM has looked at splitting up our EM allocation into more obvious sub-regions where we can express more granular investment views. For example, in the commodity price spikes following the Russian invasion of Ukraine, we looked at an allocation to the Latin American equity markets. Here, the likes of Brazil and Mexico were clear beneficiaries of higher commodity prices and their equity market composition reflected this. Similarly, in the past, investors focused on the more developed Northern Asian countries (aka the Asian Tigers) as they represented a ‘safer’ pair of hands – lower volatility but still carrying the higher growth premium of EM. Of course, the big winner of the past two years has been India’s equity market, and the success of this particular EM will have driven investors to thinking in a more nuanced way about EM in general.
Also, China, one of the giants of the EM index prior to the COVID-19 pandemic, has become less attractive to investors in recent years. Representing at its peak just over 35% of the Emerging Markets (EM) equity index, today exposure to countries domiciled in China stands at around 23%. The Chinese government’s policy response to the pandemic has forced international investors to think more strategically about their EM allocations. Geopolitics has certainly contributed to this, but not simply in terms US apathy towards China. The increasing lack of strategy from the Chinese Communist Party (CCP) towards its capital markets has also played an important part, while a downturn in the Chinese property market is slowing down a source of capital that might otherwise have entered the equity market.
Therefore, for clients with exposure to a dedicated China fund, the optimal way to blend this into an EM allocation is with an EM ex China strategy.
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Promotion approved 08/04/2024