Investors have been moving away from emerging markets over the last quarter, but that could be because they aren’t correctly assessing the opportunities that emerging market stocks present. BlackRock analysts Jeff Shen and Rodolfo Martell think that most portfolios should have significantly more invested in EM stocks than they currently do, reports Mamita Badkar for Business Insider.
MSCI Emerging Markets Index
“The same methodologies that served them well since MSCI launched the first comprehensive EM index 25 years ago may not provide adequate risk-adjusted returns over the next 25,” Shen and Martell write. “In fact, the iShares MSCI Emerging Markets Indx (ETF) (NYSEARCA:EEM) represents only 4% of the stocks listed in the emerging world. The MSCI EM Small Cap Index covers an additional 9%.”
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The issue is that there are over 18,000 EM stocks available, and there is no index capable of capturing all of them. Shen and Martell don’t even think it would be desirable for such an index to be created, but most investors are literally scratching the surface of what’s available. What’s worse, since Western investors are almost all looking at the same small segment of the emerging markets, many are concluding that all the opportunities for strong risk-adjusted returns have disappeared while Shen and Martell think that such opportunities actually abound, but they are off the beaten path.
See: Emerging Markets Face a Tsunami of Threats
Allocation to emerging market debt
They claim that “in addition to the improved fundamentals, investors may also find that an allocation to EM debt helps to capture some of the exposure to GDP that is missing from their equity approach.”
See: Emerging Markets In Chronic External Debt, Imbalance Of Labor
The average portfolio puts about 5 percent of its holdings in the emerging market as a niche, high-risk product, but the BlackRock analysts argue this should be closer to 18 percent. No doubt this would require some work. Many of the companies that they are referring to are essentially unknown in the U.S. and Europe, and reporting standards vary widely across the developing world, but there is a big upside for a team willing to put in the time researching these companies.
As Shen and Martell put it, “For investors who want to develop their portfolios, the developing world is an unmatched source of potential.”