However, emerging markets arguably encompass the broadest array of investment possibilities. The long-term potential of these economies, which account for over 80 per cent of the world’s population but just 10 per cent of the world’s market capitalisation, is huge.
The MSCI emerging markets index is comprised of almost 800 companies in 24 countries, and, according to International Monetary Fund estimates, the sector contributes half the world’s growth. Investing in emerging markets means there are many more variables to consider. Political, macroeconomic and currency factors have a major influence on the performance of companies. Regulations and governance, albeit improving, are not as comprehensive as in developed economies, which means fund managers must understand a diverse range of countries, regions and cultures if they are to succeed over the long run.
Emerging markets represent one of the few places where active managers have a good track record of beating the popular indices but, during periods of heightened volatility, there is a rotation of style leadership among managers so experience becomes more important in emerging market investing.
When selecting managers, the decision should focus very much on the skills exhibited by the team and the long-term drivers of performance that their capability implants into their portfolio. A depth of experience is sought – for example, teams who have understanding of previous crises should be better prepared to cope with what the market may throw at them.
That said, this crisis had a different starting point as it did not emanate from the region but was caused by developed market contagion. But in previous situations, currency depreciation gave emerging market countries a route to recovery through exports.
This time, there have been no massive currency shifts and there is limited demand from the developed world. A market recovery was always likely to predate a rebound in economic growth but the scale of the recent rally was surprising. Some of the most oversold stockmarkets, such as Russia, rebounded first while a lot of hope is still pinned on growth in China as it can spend some of its considerable reserves and keep its economy going. Economic prospects look brighter than at the beginning of the year but there is little room left for positive surprises and investors still have high expectations of China. Economic growth in emerging economies looks set to be slower than in past years but its trend remains positive and supportive in the long run.
If you are going to choose an active fundamental approach for any one sector, then we believe that emerging markets is a place to do it. While the risks are many, if you are prepared to accept them and can focus on the long-term positives, then the potential rewards are significant too.
Dr Eckhard Weidner is global emerging markets’ analyst at HSBC Multimanager, HSBC Global Asset Management