Emerging markets have changed: Is it time to invest?

Anyone who has ever spoken to me in depth about investing or read my book on retirement planning knows that I am a big fan of emerging markets. But far too often when I bring up the topic of allocating some investment funds into emerging markets, I am met with skepticism, and the client inevitably says that it is too risky.

Change is in the air

When investors think of emerging markets, they tend to think of countries that are loaded with natural resources, such as Brazil, and what is assumed to be their big economic driver. In Israel we know the economy has very little in the way of natural resources, aside from the recent natural-gas finds. Rather, local economic growth is being driven by innovation, technology and a growing middle class that has become a big consumer base willing to spend money on all kinds of material goods.

The story has become similar thought the emerging world. According to the World Intellectual Property Organization, as of February 2017, 46.5% of all global patents were registered in emerging markets. This is a dramatic rise. In 2005, just 20% were registered there.

Carlos Hardenberg, a senior vice president and managing director of Templeton Emerging Markets Group, writes: “Emerging markets are no longer one-dimensional. We are seeing the cultivation of a new generation of innovative companies located in emerging markets – Diversifying emerging-market economies and the opportunities for investors. At the same time, the emerging-market middle class has been on the rise. Greater consumer spending power has driven local companies to meet the demand for newer types of goods and services. We think this trend will likely continue to drive emerging-market growth and innovation.”

No more cheap toys?

I am not a big fan on spending money on toys for our children. After all, why buy something expensive that they will play with once or twice and then never so much as look at again. It was for this reason that I loved going out and buying cheap toys made in China and other Asian countries: no need to spend much, and the toys would break after one or two play sessions. Instead of taking up storage space, since they break, they can be thrown straight into the trash!

After five or six years of significant stock-market underperformance vis-à-vis the developed world, emerging markets turned in a stellar performance in 2017 with a 37% gain

Unfortunately that may be a thing of the past.

Hardenberg continues: “While commodity production and export remains vital to many economies, the region is worlds away from its commodity-only trade legacy, especially in China. China has moved from producing relatively low-end products to much more sophisticated ones. Today, the changing consumer dynamic means demand for new goods and services has pulled the manufacturing sector into new territory. Overall, we’re seeing a new generation of companies in emerging Asia moving into value-added production processes. Many of these companies have shown a high degree of innovation and sustainable growth.”

Relatively cheap?

The question then becomes whether this economic renaissance translates into an interesting investment opportunity. What we have seen over the last year is that after five or six years of significant stock-market underperformance vis-à-vis the developed world, emerging markets turned in a stellar performance in 2017 with a 37% gain.

Sometimes such a big gain would be a warning sign to stay away. Sammy Suzuki, a portfolio manager for Alliance Bernstein’s Emerging Markets Strategic Core portfolio, gives multiple reasons why it behooves investors to invest in this asset:

“Catch-up just beginning: EM companies had several tough years, with subdued earnings, low profitability and depressed valuations. There’s plenty of room to catch up with developed-market peers. And in the past, EM equity cycles persisted for several years. Between 2002 and 2007, the MSCI Emerging Markets returned an annualized 28.6%.

“Sources of returns: This year’s performance has been driven mostly by earnings growth – not multiple expansion. This indicates that there’s still plenty of pent-up return potential in EM equities.”

Risks

Investors should do their own homework before investing in emerging markets. Make sure that this type of investment fits both your investment and risk profile and will help you achieve your goals.

The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc., or its affiliates.

Aaron Katsman is a licensed financial professional in Israel and the United States who helps people with US investment accounts. He is the author of the book Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing.