18th-century British nobleman, Baron Rothschild once famously said: "The time to buy is when there's blood in the streets." In other words, the best long-term investment opportunities often present themselves when things seem to be at their worst. Today, due to a slowing Chinese economy and falling commodity prices, emerging markets are severely underperforming other asset classes. So is now the time to think about adding emerging markets to your portfolio?
Emerging Markets as an Asset Class
The term “emerging market” got its start in 1988 when Morgan Stanley Capital International (MSCI) launched the first comprehensive emerging markets index designed to measure equity market performance in global emerging markets. The idea of investing in emerging markets was given another boost in the early 1990s when the European Bank for Reconstruction and Development (EBRD) was established to help build ‘market-oriented economies and the promotion of private and entrepreneurial initiatives’ as part of a new, post-Cold War era in Central and Eastern Europe.
Today, emerging markets (EMs) sit between developed markets like the U.S., UK and Japan and 'frontier markets' which are less economically developed than EMs, according to the Financial Times (FT). Emerging markets offer a whole range of investment opportunities, mostly via exchange traded funds (ETFs) that trade on U.S. exchanges and use emerging markets as an asset class.
It has also led to a range of new acronyms. For example, the acronym “BRICs” was coined in 2001 by Jim O’Neill, then chief economist at Goldman Sachs Asset Management, to describe the four booming economies of Brazil, Russia, India, and China. O’Neill also coined the term “MINTs” (Mexico, Indonesia, Nigeria and Turkey) before leaving Goldman Sachs. Other terms for emerging markets include HSBC’s “Civets”: Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa and the “Next 11”: Bangladesh, Egypt, Indonesia, Iran, Korea, Mexico, Nigeria, Pakistan, the Philippines, Turkey and Vietnam, according to the FT.
Emerging Markets Under Pressure
Emerging markets grew in popularity following the dot-com crash of the early 2000s. China emerged onto the world stage to achieve double-digit GDP growth by 2003, according to the World Bank, and only dropped below 10% in 2011. This Chinese economic expansion led to massive demand for commodities to fuel the economic growth. As a result, emerging market economies, which tend to be commodity producers, benefited greatly, but seem to be struggling lately.
In the current market environment, China’s economy is slowing, and the demand for the goods that propelled so many emerging market valuations higher appears to be coming to an end. (For more information, see: Is the Commodity Super-cycle Really at an End?) In fact, the International Monetary Fund (IMF) expects China’s economy to grow by 6.8% in 2015 and investors now seem to be keeping their distance from emerging markets, despite all the fancy names. On top of that is concern about the timing of the Federal Reserve Bank’s first interest rate hike, which could add more pressure to emerging market performance. (For more information, see: How a Strong Dollar Can Hurt Emerging Markets.)
In another sign of how bad things are for emerging markets, one of the first closed-end emerging market mutual funds is shutting down. The Templeton Russia and East European Fund (NYSE: TRF) was established June 15, 1995, and was managed by Mark Mobius of Franklin Templeton. The fund is important because of its long track record in emerging markets. For example, it was one of the only investment vehicles at the time that allowed Western investors to participate in the booming Russian stock market of the mid-1990s. Back then, Russia was recovering from the stagnation of the Soviet period. Privatization of industry, cowboy capitalism and bouts of hyperinflation were all in full swing. Sadly, according to MareketWatch.com, Franklin Templeton announced that shareholders approved the liquidation and dissolution of the fund at the annual meeting of shareholders held on October 29, 2015. Nonetheless, twenty years and four months is a respectable track record in emerging markets.
Emerging Market Investment Opportunities
Despite all the headwinds, now may be the time to invest in emerging markets. The key to success in the emerging market is investing selectively. Unlike 1995, when the Templeton Russia Fund was one of the only games in town, there are now numerous emerging market investment vehicles to choose from. For example, some investments available to U.S. investors are listed in the table below. Still other funds are available to European and Asian investors.
|iShares J.P. Morgan USD Emerging Markets Bond (EMB)||iShares MSCI Emerging Markets (EEM)|
|Wisdom Tree Emerging Markets Local Debt Fund (ELD)||Vanguard FTSE Emerging Markets (VWO)|
|Market Vectors J.P. Morgan EM Local Currency Bond (EMLC)||iShares Core MSCI Emerging Markets (IEMG)|
Performance varies across asset class, but correlation remains high within the class, unfortunately. For example, all three equity ETFs have returns between -9% and -12% year-to-date as of October 2015, according to MarketWatch.com. Bond ETFs performance has been slightly worse in 2015 and varied mostly due to currency exposure. While EMLC and ELD have capital returns of between -13% and -15% year-to-date, EMB is closer to -1%, according to MarketWatch.com, because it is denominated in U.S. dollars. The dollar has performed well against emerging market currencies in 2015 on the back of higher expected U.S. interest rates. This is another factor to keep in mind when investing in emerging markets.
The Bottom Line
The adage of “buy low and sell high” is still a common sense approach to investing. Unfortunately, human beings are not very good at following this advice because the emotions of fear and greed get in the way. The current downturn in emerging markets is understandably fear based, with no one wanting to buy something whose value will continue to shrink. While investing in emerging markets isn’t necessarily for everyone, a small allocation can help to diversify a well-balanced portfolio. This strategy can be even more advantageous when the assets are on sale at a discount.