Why Own Emerging Market Stocks?

 

After a decade of poor performance, it is understandable that emerging market stocks are not popular. Yet, if we look at the long-run, EM stocks have performed relatively well and provided useful diversification for investors.

The following chart shows the total return for both EM stocks and the U.S. market’s S&P500 for the 1988-2018 period, a period of 31 years that encompasses the modern history of emerging markets as an institutional asset class. The chart also shows the returns of a 50/50 portfolio re-balanced at the start of every year.

Even in the wake a a period of huge outperformance for the S&P500, EM stocks are still outperforming U.S. stocks by a slight margin over the period. However, they achieve this with deeper draw-downs (maximum loss during a year) and with greater volatility, two attributes that unsettle investors. The Sharpe Ratio (annualized return/standard deviation of annual returns) is much worse for emerging markets. Moreover, this is before considering the higher risk and cost of capital for investing in EM. When investing in EM, investors expect to be paid a premium to compensate for the higher risk, but this has not been the case over the period.

Nevertheless, EM does provide valuable diversification benefits. A simple annual re-balancing strategy (50% EM and 50% S&P500) enhances returns significantly, while providing a much more stable path of capital appreciation. This is because the two asset classes show highly uncorrelated returns over multi-year periods. During the period under consideration both asset classes individually go through extended periods of stagnation which are largely avoided through a re-balancing strategy.  For example, U.S. stocks provided zero returns between 1999 and 2009, a period which saw EM nearly triple in value. The following decade(2009-2018)  saw the reverse happen, with stagnation for EM stocks and high returns for U.S. stocks. The chart below illustrates the returns of EM, the S&P500 and an annual re-balancing strategy.

 

Trade Wars

India Watch

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China Watch:

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China Technology

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Brazil Watch

 

EM Investor Watch

Tech Watch

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