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Thematic Investing: Going Global, Emerging Markets

The world is full of opportunities, yet Americans’ “home bias” in investing may limit both diversification and opportunity for their investment portfolios. While many Americans intuitively realize the advantages of international investing, even now institutional investors have limited non-US assets. Currently, the average US institution has 75% of stock portfolios in domestic equities, and 25% in international/global stocks (according to Greenwich Associates). This is quite small when you consider that the US accounts for only $14.5 trillion of the $78 trillion of global GDP, or about 18%, or in other words – more than 80% of global GDP (largely an indication of the size of a country’s economy) originates outside the US. The demographics play is a big one and one I have mentioned before.

Countries are divvied up into 1 of 3 categories: developed, emerging/developing, or frontier. MSCI Barra, a provider of domestic and international equity indexes, analyzes 74 markets around the world on four market accessibility criteria, including: (1) openness to foreign ownership, (2) ease of capital inflows/outflows, (3) efficiency of the operational framework, and (4) stability of the institutional framework. Based on their performance in these areas, each market is slotted into one of three categories: developed (23 countries), emerging (22 countries), or frontier (29 countries). Fairly recently, Israel was upgraded to the status of “developed.” Even though the national debt of Brazil and South Korea is considered “investment grade” they are still considered emerging market countries.

Emerging Markets Come to the Fore

Perhaps on the biggest opportunities that exists over the longer term is in the area of emerging market stocks and bonds. Possibly the greatest opportunities over the next 10-15 years lie overseas in emerging markets such as China, India, and Brazil. If investors are hesitant about stocks in this area, move to the next best thing, emerging market bonds. In the next few years we see a world of muted growth, especially in the most developed nations, and higher economic growth in the most important emerging economies, lead by China. The recent downturn has shown that despite reduced global barriers and an increased amount of cross-border investment, the correlation between the US and Chinese markets is moderate at best, with China equities outperforming US stocks in 2009. Despite numerous options and attractive returns, however, many investors have been hesitant to invest in China, opting for more traditional and developed markets in a period of market turmoil.

There is no guarantee that China will continue its rapid economic expansion into the next decade; the tremendous returns generated year-to-date obviously cannot continue indefinitely. And exposure to the Chinese markets certainly comes with its fair share of risks. But the arguments for inclusion of Chinese securities in a well-diversified portfolio are compelling, particularly in our current economic environment.

A number of financial trends have made emerging economies the high-growth option for international investing. As companies worldwide have worked to reduce production costs, a wave of outsourcing has taken advantage of emerging-world capacity and fueled the growth of those economies. To be sure, emerging markets sold off more than the developed markets when the global economy rolled into recession last year. Now, however, we are starting to see signs that the global economic cycle is beginning to turn. As a result, we think now is the time to invest more money into emerging markets.

Although many developed economies will likely remain mired in a recession for months after the United States recovers, some countries are showing early signs of stabilization. It is also significant that signs of renewed life in many emerging economies are even stronger than in the developed world. Indeed, many of these governments have poured immense monetary and fiscal stimulus into the global economy. China, in particular, has poured an enormous amount of money into its economic stimulus program. A monetary stimulus often takes about 12 months to affect an economy. A fiscal stimulus also takes time to take effect. The emerging signs of economic stabilization suggest that those government efforts may finally be taking hold.

Investors need to remember, however, that investing in emerging markets involves risks. Broad diversification and specialized expertise are two important tools to help control the risks of investing in the emerging markets. While there are several compelling arguments in favor of emerging market investing, the risks should be considered and mitigated.

To learn more, read our Introduction to Thematic Investing. We strive to identify global themes that we believe are most likely to be important long-term drivers of the global business environment. Then we use intensive fundamental research and a wide array of quantitative tools to invest in companies that stand to benefit as these themes unfold. We believe this approach we help us to steer clear of trouble and stay focused on what's working, and making money.

Green Valley Wealth Advisors | Sept. 22, 2009

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Disclaimer: All articles are for informational purposes only and do not constitute offers/solicitations to sell or purchase any security or investment product or service; this information is provided solely for your personal use and is not intended to be investment advice; all investments are subject to risks, including possible loss of the principal amount invested; diversification does not protect against a loss in a declining market or ensure a profit; stocks of companies in emerging markets are generally more risky than stocks of companies in developed countries; foreign investing involves additional risks including currency fluctuations and political uncertainty; prices of mid- and small-cap stocks often fluctuate more than those of large-company stocks; investments in bonds are subject to interest rate, credit, and inflation risk; past performance is no guarantee of future results; nothing constitutes tax or legal advice; investment products described herein are not bank deposits; are not insured by the FDIC or any other governmental entity; are neither obligations of, nor guaranteed by Green Valley Wealth Advisors, LLC. We are not responsible for the accuracy or content on third party websites; any and all links are offered only for use at your own discretion; and our privacy policies do not apply to linked websites.