Investors bold enough to venture into emerging market equities after the technology, media and telecom bubble have been well rewarded. The MSCI Emerging Markets index returned about 250 per cent over the past decade, according to Financial Express, compared with 15 per cent from developed world stocks. This outperformance triggered a surge of interest in the region and inflows into emerging market funds.
Data published last week by the Investment Management Association showed British retail investors ploughed almost £1.7bn into the global emerging markets sector in 2010, more than the previous six years combined. Sales reached a crescendo towards the end of the year as net inflows hit £337m in November, the highest monthly amount on record, before falling back to £135m in December.
However, turmoil in the Middle East and North Africa (Mena) region has forced investors to confront the geopolitical risks attached to emerging market exposure. Democrats around the world may have welcomed the demonstrations in Cairo but stockmarkets were less enthusiastic – Egyptian equities fell by about 15 per cent in late January and early February as investors reacted negatively to the prospect of political instability.
Adviser Fund Index panellists say they largely rely on emerging market fund managers to make calls on geopolitical risk. Charles Stanley investment manager Shauna Bevan says: “Managers should be able to take political risk on board and it is not something we target specifically. We do not necessarily avoid countries where political risk is high but we make sure we are compensated for those risks.”
City Asset Management research director James Calder also expects higher returns as recompense for the additional risks in developing stockmarkets. But Calder notes most emerging market managers have a low exposure to Middle East and North Africa countries and he expects the long-term impact on equity valuations to be muted.
He says: “There are short-term worries over food price inflation and demographics – large, underemployed workforces in the Mena region are a problem. But we are still reasonably positive on the emerging markets, although perhaps less so on a relative basis than we were 12 months ago.”
Bestinvest senior investment adviser Adrian Lowcock says geopolitical risk is just one of the factors that emerging market investors have to consider. He recommends a maximum allocation of 10 per cent in emerging markets and one or two per cent in frontier economies.
Lowcock says: “There is political risk, currency risk and regulatory risk. Companies that do business in Brazil do not necessarily have the same policies and processes that a similar company would have in America, for example. They probably would not have the same shareholder rights. Investing in emerging markets by its very nature will always be risky – the higher the potential return, the higher the risk.”