Why invest in emerging markets? The reasons are well understood. Rising living standards are driving demand for goods and services, leading to compelling investment opportunities across countries and sectors.
How can we invest in emerging markets? That is the tougher question. The ways to access those investment opportunities are changing as markets in emerging economies evolve, and we believe it is time for a rethink in a number of areas.
- Growth will not necessarily come from the largest companies
Mega-cap companies are often identified with emerging market growth.
However, it is the smaller companies that have historically done better. Investors who seek small- to mid-cap firms most exposed to rising living standards are likely to uncover better opportunities.
- Dividends matter more than they seem
Investors typically associate emerging market growth with capital appreciation, but dividends make up an important part of total returns too. Importantly, companies that consistently pay dividends at above-median yields have generated the best risk-adjusted returns among emerging market stocks.
- Focus on economic exposure
Investors often assume that companies based in emerging markets give the best exposure to rising living standards. However, that is not always the case. A large part of the growth in certain sectors is captured by multinational corporations and companies based in developed markets. Taking a domicile-neutral approach can help investors gain the exposure they seek.
- Fixed income is not just for reducing risk
Investors tend to view fixed income as a risk-reducing tool, but it can have a strong return-generating role in an emerging market context. As the emerging market debt universe evolves, some subsets offer opportunities for meaningful returns.
- There are ways to manage volatility
The ability to invest across the entire range of emerging market securities, including stocks and bonds, can create meaningful diversification. When we consider the strong return-generating role that some emerging market bonds can have, combining them with equities potentially leads to equity-like returns with lower volatility.
Reconsider your investment strategy
With these observations in mind, how can one invest in emerging markets?
Investors targeting capital appreciation should seek exposure to rising living standards, which can be captured not only by companies based in emerging markets, but also by companies based in developed markets. Small- to mid-cap companies in emerging markets also have the potential to grow faster than mega-caps.
Investors seeking income should recognise the yield opportunities that exist in emerging economies, whether in equity or fixed income.
For investors who emphasise capital preservation, having the flexibility to invest across the full spectrum of emerging market securities can help generate a smoother pattern of returns.
Andy Budden is an investment specialist. He has 21 years’ of investment industry experience and has been with Capital Group for 10 years. Prior to joining Capital, he worked at Watson Wyatt Investment Consulting. He holds both a master’s degree and bachelor’s degree in engineering from the University of Cambridge. He is an associate member of the Institute of Actuaries. Andy is based in Singapore.
