There was never any doubt that emerging markets would become a hot topic once China was assigned the responsibility of bringing the world out of the depths of the global financial crisis. But even the proponents of this belief would be awed at the rising fund flows into this asset class. Globally, flows into emerging market funds have reached record highs, whilst the developed world continues to suffer outflows.
No conversation with a fund manager these days goes by without the eventual discussion about emerging markets. These conversations invariably lead to a mountain of statistics that are used to make their point. Whatever the case for investing in emerging markets, it appears to have convinced many advisers too
Whilst it’s important to have an exposure to emerging markets in a global equities portfolio, what is not generally well articulated is the most efficient manner in accessing these markets. Fund manufacturers who have specific emerging markets funds, regional funds or even country funds would argue for the merit of their offer.
However, from a portfolio implementation perspective, funds of this nature would be the most difficult and expensive solution. For planners, an assortment of different funds would be difficult to monitor, let alone rebalance. And from an investment perspective, this solution is handicapped by managers who can’t screen companies using broader comparisons. For example, a manager of a China only fund who has discretion to only invest in companies listed in China may be forced to buy a telecommunications firm which may not be the best value or inferior in quality when compared to a telecommunications company that is listed on a developed market.
Overcoming this shortcoming is no easy task. Not many investment managers have the capability to conduct due diligence globally and back those views by selecting a handful of firms which represent their best ideas. A fund that is truly global, where the portfolio can be invested in the best valued companies, irrespective of where they are listed, remains the best solution for investors. Such a solution removes the need for advisers to make active decisions about the specific portfolio exposures and country political risk, which is a key driver of returns from many emerging markets.
The need to make the regional capital allocation decision is crucial as markets tend to get overvalued or undervalued much faster than many realise. If during such market volatility, a fund manager is not given the full flexibility to execute their best ideas, you may actually be hurting the overall wealth outcomes to investors. Emerging markets traded at a discount with their developed markets counterparts for nearly a decade up to the year 2000. But since then that discount has closed, and currently these markets are trading at a premium.
I won’t go into whether or not this is justified, but the question remains: if you have a specific allocation to these markets, what would you do now? These are the sorts of questions that advisers who use a fully implemented global share solution can authoritatively and confidently delegate to experienced fund managers to answer.
Emerging markets have substantially matured since the Asian Financial Crisis in the late nineties. What is now needed are mature ways of accessing these markets.
Kajanga Kulatunga is an investment specialist at MLC
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