Global growth weighted in favour of emerging markets

With emerging markets set to make up more than 62 per cent of world GDP by next year – up from 54 per cent – now is perhaps the time to seriously look at including an emerging market exchange traded fund in your portfolio.

Rachel White, head of product management for Vanguard Australia, says there is an increasing interest in emerging market ETFs thanks to a variety of factors.

These include the current low-yield environment, a somewhat muted outlook for Australian equities in comparison to the last three decades of growth and forecasts that emerging markets are likely to outperform developed markets for the next 10 years.

With $653 million in assets under management, Vanguard’s FTSE Emerging Markets Shares ETF (VGE) is an index ETF which tracks the return of the FTSE Emerging Markets All Cap China A Inclusion Index.

“VGE gains exposure to emerging markets by investing in Vanguard’s US-listed Emerging Market Equity ETF, VWO, which has $US80 billion ($108 billion) in assets under management, resulting in a very liquid exposure,” she says.

“The ETF is a highly diversified product providing investors with access to over 4000 securities across a range of sectors, with technology the largest exposure at 25 per cent of the index.

“The ETF can help investors diversify their portfolio into sectors and companies that are not well-represented in Australia.”

VGE invests across the full market capitalisation spectrum of emerging market countries, with China the largest, making up 40 per cent of the index, followed by Taiwan at 18 per cent and then India at 13 per cent.

“Over the last five years, the ETF has returned 10.92 per cent a year and 27.67 per cent over the last 12 months.”

However, investors need to be cautious about investing too heavily in any specific area in one’s investment portfolio, White says.

“Asset class returns are ever-changing,” she says. “What performed best last year might not make the podium next year, so spreading your risk over several asset classes, instead of just the one, will invariably smooth out your overall returns over time.

“That’s why owning a portfolio with at least some exposure to many or all key markets over the long term can provide the opportunity to participate in stronger areas while mitigating the impact of weaker areas.”

Owning units in an emerging market ETF is also better than attempting to pick your own international winners.

“It’s never wise to put all your eggs in one basket,” White says. “The idea of a broad-market, well-diversified ETF is based on the concept of spreading your risk across a range of industry sectors and assets.

“In buying a single ETF, an investor is typically able to get access to entire markets – or segments thereof – rather than selecting an individual company. This can reduce the risk of an investment portfolio, and can also be a great way to save on time and cost.”

ETFs are also efficient at getting access to shares in markets overseas that can be particularly expensive and difficult to purchase directly, which is a challenge with emerging market equities, she says.

“Like most things in life, successful investing is all about balance. An investment portfolio should not be too heavily tilted towards a specific area, whether it is towards Australian equities or emerging markets.

“The use of emerging market ETFs exposes investors to economies which have the opportunity to grow faster than many developed market economies. China, for example, is now an essential part of the world economy. An emerging market equity ETF allows investors to participate in the long-term growth potential of companies in these sectors.”

Stuart Morley, professional services firm PwC’s lead partner, wealth and debt advisory services, says when considering the emerging market mix of your investment, a good starting point is the MSCI emerging markets index top 10.

“You’re looking at the likes of Taiwan, China or South Korea – particularly China,” Morley says.

He says that when considering the right emerging markets manager, it’s important to query whether they have a proven ability to deliver value in varying market conditions and protect investor capital in more turbulent times.
Anthony Doyle, cross asset investment specialist at Fidelity International, says that with the changing landscape, emerging market economies are beginning to account for a much higher percentage of global GDP.

“The IMF World Economic Outlook Database showed that in 1980 these nations had a combined GDP of less than half that of advanced economies. By 2010, the two were close to level,” Doyle says.

By next year, it is estimated that emerging economies will have an output that is larger than the developed world.

“In just four decades, emerging markets will have gone from a peripheral position in the world economy to a central one.

“Despite this, they still account for just a fraction of most Australian investment portfolios, and an option that has been overlooked by many investors.”

The Fidelity Global Emerging Markets Fund gives investors access to a diversified portfolio of 30 to 50 quality companies in emerging markets, he says.

Because of the risks associated with emerging market economies, they often generate higher-than-average returns for investors.

“Not all are good investments, but for those investors willing to research and focus on identifying high-quality names, emerging markets will remain an attractive proposition for some time yet,” he says. “And for investors who are investing for the long term, they have the long-term timeframe needed to ride through the emerging market peaks and troughs”.

And the future?

“There are many reasons for investors to remain optimistic towards emerging market equities, which are set to benefit from long-term structural growth drivers and more recent global developments, namely those relating to technology and the new stay-at-home phenomenon,” Doyle says.

“Greater diversification across countries, sectors and companies affords investors the ability to take into account the varying impacts of COVID-19 on emerging market economies, the sectors and the companies themselves.

“However, as volatility levels remain elevated, selectivity remains paramount. Against this backdrop, a focus on identifying companies characterised by robust corporate governance and balance sheet structures is key.”

All said, the outlook for emerging markets is positive, Doyle says, with emerging market economies with large domestic consumption to benefit from disruption of supply chains over the short to medium term.

“The rise of regional economic centres, where growing demand from a large economy like China or India, will also fuel growth in other developing countries nearby.

“Couple this with strong domestic consumption as a result of a rising middle class and the evolution of growth industries, and there is quite a compelling case for investing in emerging markets.”

Published by Fidelity