Emerging market equities remain attractive in terms of traditional valuations despite the disappearance of the risk premium compared with developed countries.
The growth outlook for emerging countries is such that their equities still seem to be relatively undervalued.
Internal analysis at BNP Paribas shows the correlation between emerging and developed markets is now 90 per cent compared with 50 per cent in 2000, so the diversifying power of emerging equities seems to have been reduced. Closer analysis reveals we can see this correlation holds for the Bric economies, which is perhaps not surprising, given they are the four emerging markets among the highest market capitalisation. However, if we compare the stocks making up the MSCI emerging market index, we can see the correlation remains low at between 30 and 40 per cent, although the trend is towards long-term growth.
But what about liquidity? In the early 1990s, the liquidity of the developed countries’ equity markets was 40 times higher than that of emerging markets. It is now only 10 times greater. The proportion of companies trading between $10m and $100m per day is now around 55 per cent of the total MSCI emerging market index universe for both emerging and developed markets, which should further reassure investors concerned about liquidity.
So why invest in emerging equities now? Emerging markets are still clearly underweighted in terms of stockmarket capitalisation. This is probably because market capitalisations are usually calculated on a free-float basis in the global indices – by looking at the share of the capital freely traded on the markets (unlike the rest of the capital which may be held by the government for example). This accounts for 56 per cent of the total capital in emerging countries, compared with 82 per cent in developed countries. Based on this float-adjusted calculation, emerging markets currently account for 13 per cent of the global market capitalisation. However, if we look at the total market capitalisation, this figure rises to nearly 21 per cent, which is a theoretical weight but illustrates the longer-term trend. This will be further enhanced by the increased number of IPOs. Currently, 70 per cent of IPOs are made in emerging markets compared with 20 per cent in 2000.
The weight of emerging countries in the global GDP is calculated at 28 per cent, with economic growth projected to be greater than in developed countries. It is likely the associated financial weight should follow the same trend. If we assume the financial weight of emerging countries will one day fall into line with demographic weight, theoretically, the proportion could increase to over 80 per cent.
Investing in emerging equities still makes a lot of sense but generating a decorrelated performance is no longer as simple, so how can multi-manager portfolios take advantage of these trends?
The answer is simple to suggest but hard to execute. Research, research, research should be the maxim and implies a certain level of resources to fully identify and exploit opportunities.
Hans Hamre is director, head of global equities at FundQuest