The emerging market equity universe has become bigger, broader and deeper. Over the past five years, clear style distinctions among investment managers have emerged; these style groups have generated differentiated patterns of performance-patterns that, in some cases, are negatively correlated (where one security will move an equal amount in the opposite direction of another).
In our view, this differentiation presents an opportunity to blend style exposures, smooth portfolio volatility, achieve higher risk-adjusted returns and better determine asset class entry and exit points.
The below chart shows the expansion in capitalisation of the broad MSCI indices. As it demonstrates, the market cap of the MSCI Emerging Markets Index has grown 200 per cent over the past five years, outpacing all other broad indices.
Source: MSCI
Our research has confirmed that investors may now exploit the benefits of style diversification across emerging market equities by structuring portfolios along style lines. As has occurred with other major asset classes, the number of investable companies and countries has broadened the emerging markets opportunity set.
Growth stocks for example have generally outperformed when the economic backdrop is muted, as is currently the case. Although we expect emerging markets to outperform western markets where banks, governments and consumers are all involved in a protracted process of balance sheet reduction, we still expect a more modest recovery.
When the asset class was most attractive in the first half of the 1990s, valuations tended to be 15 or 20 times earnings on a forward basis. Today emerging markets are on 11 times forward earnings and the MSCI World is on 12.5 times. Part of the reason why growth can be expected to outperform, and why the GARP style is also attractive, is because we are in an environment very similar to the 1990s. In the early 90s, growth outperformed value. The US was coming out of a recession, post the S&L crisis, so growth was challenged. As a result, emerging markets were offering stronger economic and earnings growth (Peter Gillespie pictured right).
What does this mean for investors?
The development of emerging markets as an asset class over the past ten years has provided managers the opportunity to exploit growing country, industry, and security investment trade-offs. This has allowed investors to benefit from specialised patterns of return and risk, according to their objectives.
Growth, value, core, and sub-style cycles exist within emerging markets and blending styles can now be considered at a portfolio structure level. We believe that diversifying emerging markets equity exposure by manager style presents an opportunity to:
- Blend style exposure
- Smooth portfolio volatility
- Offer higher risk-adjusted returns relative to single manager mandate
- Allow investors (or managers) to better determine asset class entry and exit points
Therefore, if you already hold one emerging markets strategy, such as a value fund, there are great benefits to adding another style; growth stocks are currently trading at attractive valuations. If you are looking to add to your growth exposure, the style is ideal for where we currently are in the market cycle.
This is a financial promotion and is not intended to constitute investment advice. In the UK this document, which is supplied for information only, is for distribution only to professional investors and advisers authorised to carry out business under the Financial Services and Markets Act 2000.
Past performance is not a reliable indicators of future results. Investors are reminded that the value of shares and the income from them can fall as well as rise due to stock market and currency movements. When you sell your investment you may get back less than you originally invested. Fluctuations in the rate of exchange between the currency in which shares are denominated and currency of investment may have the effect of causing the value of investment to diminish or increase.
Any individual securities or sectors mentioned are not necessarily held by Lazard Asset Management and should not be viewed as a recommendation or solicitation to buy, sell or hold these securities. It should also not be assumed that any investment in these securities was or will be profitable.
Investments in emerging markets carry an above-average degree of risk due to the undeveloped nature of securities markets in the emerging countries. Investors should consider whether or not investment in emerging markets strategies is either suitable or should constitute a substantial part of their portfolio.
Peter Gillespie is co-portfolio manager of the Lazard Developing Markets fund. The views expressed here are his own.