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02/01/2012

How and Where Should You Invest in Emerging Markets?


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As the new year failed to ring in a solution to the debt crisis that has transfixed the eurozone, investors are left wondering whether now is the time to place their bets on potentially risky growth opportunities or to keep their assets in safe havens. Beyond Europe’s sovereign credit issues, other factors such as massive debt overhang, the threat of double-dip recessions, and ongoing money printing by central banks in the developed world call into question the traditional definition of “safe.” In this environment, some money managers are asking whether investing in emerging economies may, in fact, be safer than committing assets to developed markets.

INVESTING GLOBALLY OR LOCALLY?

Arjun Divecha, chairman of GMO LLC’s board of directors, sees growth opportunities in emerging markets. In an August 2011 white paper from GMO, he wrote that “more of the hours worked, more of the money earned, and therefore, more of the money spent will be located in the emerging markets.”

Investors looking to enter into emerging market investments often wonder how their money should be invested. Multinational companies with a presence in emerging markets may have their profits diluted by poor performance from their operations in developed markets, but companies based in emerging markets can often be an expensive alternative to developed multinationals when approached from a valuation perspective.

“In our mind, it is not an either/or issue,” says Mr. Divecha. “The ideal portfolio should be indifferent to domicile, but focus on which companies are best able to take advantage of these opportunities.”

GMO has spent considerable time examining investment opportunities offered by companies based in emerging markets, and Mr. Divecha has noted that not all market sectors are equal. In some cases, an excess of competitors can keep a sector’s high growth from translating into high shareholder returns, whereas other sectors may already be relatively developed with little room for growth.

RESILIENCE IN EMERGING MARKETS

In the coming year, emerging market allocations may be tested by any number of adverse scenarios that unfold in the global economy. In a recent Financial Times article, Martin Wolf wrote that the sustained growth of emerging countries cannot hope to rejuvenate sluggish economies in developed markets, declaring that “emerging countries are not immune to low-probability, high-impact disasters.”

George Hoguet, CFA, global investment strategist at State Street Global Advisors (SSGA), agrees with Mr. Wolf’s assessment, noting that because of the relative size of the European Union’s economy, “it is impossible even for the US to decouple from a significant recession in the EU.” However, Mr. Hoguet believes that emerging markets would be able to withstand a mild recession in the eurozone economy.

Another concern is the slowing growth of China’s economy. In a recent Bloomberg interview, Fraser Howie of CLSA Asia-Pacific Markets warned that China faces “hard times” ahead.

Decreased demand from China could create problems for commodity exporters in emerging markets. A January 15 Reuters article noted that Taiwan, Malaysia, and South Korea have already reported slowdowns in exports to China.


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EMERGING MARKET ASSET ALLOCATIONS

Mr. Hoguet, who is State Street’s senior emerging markets portfolio manager, thinks that despite the risks, emerging market investments belong in investment portfolios that seek positive returns in the coming year. In his recent interview with Barron’s, he expressed doubt about the idea that developed markets could outperform emerging markets in 2012, saying, “if global equity markets rally, emerging markets will outperform.”

Anticipating several more quarters of below-trend growth for developed economies, Mr. Hoguet notes that Citibank estimates indicate that the eurozone and the United Kingdom will need until 2016 to get back to 2008 levels of output. Although emerging markets suffered in 2011 as European banks cut funding for emerging markets in order to cover losses and meet their own balance sheet requirements, SSGA’s tactical asset allocation accounts are overweight in emerging market equities.

According to Mr. Hoguet, “the Great Recession has enhanced the case for investing in emerging markets, by enhancing their growth differentials.” He also noted that the share of emerging market equities in global equity capitalization continues to rise.

EXPERT OPINIONS ON EMERGING INVESTMENTS

Investors who want to learn more about ways to withstand the headwinds from rising inflation and currency volatility in order to obtain superior risk-adjusted returns in emerging markets can register to attend the upcoming Investing in Emerging Markets: After the Great Recession conference, hosted by CFA Institute and the New York Society of Security Analysts in New York on March 1–2, 2012 .

At the conference, Mr. Hoguet, Mr. Divecha, and Mr. Howie will be among the array of speakers—including experts from firms in Malaysia, Argentina, Brazil, and Europe—leading sessions that focus on investing in China, Brazil, Russia, Eastern Europe, Africa, and other emerging markets. Topics will include ways to enhance valuation and risk allocation processes for emerging and frontier market investments, market- and sector-specific analyses of investment opportunities, and the unique political and economic risks in emerging market investing.

More information about the conference is available on the NYSSA website, where individuals can read details about the conference agenda and register to attend the event.

–Peter M.J. Gross

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