Swings in performance support the case for broad exposure in emerging markets, L&G Investments’ Dan Attwood says
Emerging markets are clearly still attractive for long-term investors, however growth and equity market returns can vary hugely amongst developing countries, with little consistency year to year, creating challenges for investors and their advisers, L&G Investments says.
Many emerging economies have been reporting their Q1 growth figures in recent weeks. Turkey reported today beating forecasts with 3% growth year-on-year in the first quarter 2013. Two weeks ago, Brazil disappointed markets as it grew less than expected at 1.9% year-on-year. However, the Philippines vastly exceeded expectations with growth of 7.8%.
Dan Attwood, proposition manager, Retail Index Funds at L&G Investments considers these challenges and how the swings in performance support the case for broad market exposure.
Beware the swings of performance
“The equity returns of different emerging market countries fluctuate significantly, meaning it is difficult to predict which countries will out or underperform in any year. There is little consistency seen among the top and bottom performing emerging market countries over the past nine years; a top performer one year could quite easily be at the bottom the next.
“For example, Poland recorded a performance of -28% in 2011 and +38% in 2012, jumping from bottom five to top five performer within a year. Turkey, the best performing emerging market in 2012 with a return of 60.74% was a bottom five performer the year before with a performance of -35.38% in 2011.
“With the patchy performance of emerging markets, trying to predict which country will perform well year to year is very difficult. Capturing the performance across the whole emerging markets opportunity set, and mitigating the risk of over-exposure to a limited part of it, is clearly a sensible approach.”
The challenge of accessing the emerging markets
“Emerging markets continue to attract attention from investors, however the demand for funds has not been matched by quality of supply. A number of the best performing and hence most popular active funds have seen such strong inflows that they have reached capacity, forcing them to soft-close to protect the interests of existing investors. In addition, many actively managed funds have biases towards certain regions or individual countries, understandably reflecting the core knowledge base of the lead manager or his/her location.
“Index funds offer an interesting alternative for investors. They, conversely, provide broad and low-cost exposure to the fast-moving emerging markets. As index funds buy the whole of the market, they are highly unlikely to encounter any capacity constraints. Indeed, as the funds get larger they are able to generate greater efficiencies and reduce costs. They also evolve in line with developments in the underlying markets as indices rebalance, allowing them to incorporate the next generation of emerging markets into the portfolio.”