Why emerging market investors should avoid bandwagons; In more peaceful times, investors are modestly rewarded for taking emerging market risk, but to benefit fully they need a contrarian approach and to avoid jumping on bandwagons

Why emerging market investors should avoid bandwagons

In more peaceful times, investors are modestly rewarded for taking emerging market risk, but to benefit fully they need a contrarian approach and to avoid jumping on bandwagons

Emerging markets represent 13pc of the value of the world’s stock markets today and a third of global economic output. That compares with just 1pc of market capitalisation and 18pc of GDP 30 years ago. 

By Tom Stevenson

8:00PM GMT 15 Feb 2014

Emerging markets represent 13pc of the value of the world’s stock markets today and a third of global economic output. That compares with just 1pc of market capitalisation and 18pc of GDP 30 years ago. The developing world is no longer a niche interest for adventurous investors – it is too important to ignore.

Unfortunately, the relatively recent development of many emerging stock markets (over not much more than 20 years in Russia, China, India and Eastern Europe) means long-running data have been hard to find. Many of the rules of thumb about investment strategies are, as a consequence, really a reflection of what has worked and not worked in developed markets such as the US and Britain.

That might explain why investors have latched, intuitively but randomly, on to factors like GDP growth and country size when deciding how to invest in emerging markets. Perhaps we should not be surprised that the links between these and subsequent returns have not been helpful.

Good news then that three professors from the London Business School – Elroy Dimson, Paul Marsh and Mike Staunton – have just completed a useful analysis of emerging market returns over the last 100 years or so.

Their report, for Credit Suisse, goes some way to answering the question: how should I invest in emerging markets? The most useful conclusion is that value is an important driver of emerging market returns. The “LBS Three” identified this by a strategy that ranked up to 59 emerging markets by dividend yield and then recorded and analysed their subsequent performance.

The countries were re-ranked each year between 1976 and 2013 and the following year’s returns grouped in five equally sized “buckets”. The performance of the countries with the highest fifth of dividend yields could then be compared with those with the lowest yields and with those of the three groups in between.

The outperformance by high-yielding markets is impressive. Low-yield countries had an annualised return of 10pc while the highest yielders returned 31pc a year.

Two other factors that appear to have a strong influence on returns are the strength of a country’s currency and its recent (five-year) GDP growth. Currency weakness is good for equity returns, which is logical when you consider the extra competitiveness a falling currency can give an export-dependent country.

Less obviously intuitive is the fact that countries which have experienced low GDP growth have tended to outperform those which have grown quickly. Again the difference between the best and worst fifths is significant – the lowest-growth group of countries had an annualised return of 28pc a year between 1976 and 2013 while the highest-growth quintile grew by 14pc.

This undermines much of the commentary on emerging market investing in recent years which has focused on the high growth of the developing world versus the West. The shift in the economic balance from West to East has been trumpeted as a reason for investing in emerging markets, but a focus on growth has actually been unhelpful.

The most likely explanation of these trends is that economic growth and foreign exchange are just proxies for the value demonstrated by the dividend yield. Countries with weak currencies and low growth tend to be distressed or higher risk. That means that investors demand a bigger reward for investing in them.

They are cheap and so better placed to outperform. By contrast, those countries where everything seems to be going swimmingly are popular with investors, expensive and likely to underperform.

Two factors that appear to have little bearing on future returns are the size of a country or the recent performance of its stock market. In the long run (since 1900), emerging markets have underperformed the developed world, although there have been long periods like the 1960s, 1970s and the period from 2000 to 2010 when they have done much better.

Much underperformance is, however, due to wipe-outs in Russia, China and Japan due to revolution and war. In more peaceful times, investors are modestly rewarded for taking emerging market risk, but to benefit fully they need a contrarian approach and to avoid jumping on bandwagons.

Tom Stevenson is investment director of Fidelity Personal Investing. The views expressed are his own. He tweets at @tomstevenson63

 

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: