Why EM Still Fits in Your Portfolio

How have emerging markets evolved in the last few decades?

Much has changed since the heyday of emerging markets (“EM”) investing back in the early 2000s. In fact, from 2003 to 2007, the ‘BRIC’ economies—referring to Brazil, Russia, India and China—led one of the strongest rallies on record. Cyclical export-oriented businesses along with commodity and resource companies jumped, and the prospects of a consumer-led boom led by China took hold of markets. Although half of that BRIC acronym, Brazil and Russia, have disappointed in terms of growth over the last decade, I believe EM can still provide important cyclical value-oriented exposure, which can be additive during times of post-recession recovery. We've witnessed some of that benefit in the last 18 months from the market lows in March 2020. What has changed is the influence of Asia within EM benchmarks. And within Asia, China's become the epicenter of growth and influence followed by South Korea, Taiwan and India. As of June 30, 2021, Asia represents over 75% of the MSCI Emerging Markets Index, and the region’s growing prominence in emerging markets makes it increasingly important to get the Asia part right.

Given that emerging markets equities have underperformed the developed equity markets over the past decade, should emerging markets continue to play a role within international portfolios considering their higher volatility?

Yes, certainly in my mind, EM should play a role in investors’ portfolios. And it’s true that EM equities have underperformed during the last decade, but remember, the decade prior to that was almost the mirror opposite—EM equities dramatically outperformed the S&P 500 Index. Several factors have contributed to EM equity underperformance in the past 10 years. One prominent reason is the incredible performance of U.S. stocks during this period. Now we can all debate whether U.S. stocks will continue to deliver, however it's my opinion that EM equity’s relative underperformance may be turning around for a couple of reasons.

First, U.S. corporate earnings could come under pressure with the proposed higher corporate tax rates and the reduction of U.S. liquidity through the forecast tapering of the U.S. Fed’s bond purchasing program.

Secondly, if you believe the global economy has entered a period of economic growth with slightly higher inflation, you've just described what we've experienced several times in the last 30 years. And during those previous periods, on average, EM and Asian equities were the top asset class performers, higher even than the S&P 500 Index and MSCI EAFE Index in most cases.