Thanks to the promise of high growth, emerging market exchange traded funds (ETFs) have been the darlings of the investing world since the economic recovery first sprang to life. But whether it’s roundly true that emerging markets will always outperform developed ones is another question altogether.
Emerging economies have a much healthier balance sheets compared to the developed world, remarks Chris Sholto Heaton for IndexUniverse. Emerging markets should produce higher returns that reflect their greater risk and their higher GDP growth should translate into higher returns; however, GDP growth is only one component of total long-term equity returns. [Emerging Market ETFs: A Temporary Pause?]
Emerging market investors should consider other factors that are linked to return, like equity markets as a source of financing, the makeup of the market as compared to the economy, the dependence of domestic companies on their domestic economy and the corporate attitude toward rewarding shareholders, among other factors.
Elroy Dimson, Paul Marsh and Mike Staunton of London Business School and co-authors of “Triumph of the Optimists” took a closer look at the history of emerging markets with the aid of the the latest Credit Suisse Global Investment Returns Yearbook. It was discovered that in 110 years, only six countries have risen to developed status, but if Israel, South Korea and Taiwan are counted, the number may be considered nine. [Time for a New Emerging Market Approach?]
Using the S&P/IFCG Emerging Index, Dimson, Marsh and Staunton compiled an emerging market index of 17 countries dating back to 1975 and found that emerging markets slightly underperformed, with an annualized total return of 9.5% versus 10.5% for the MSCI World. Furthermore, individual countries didn’t show much of a link between equity returns and growth. [Eastern Europe Could Top the E.U.]
However, if one factors in economic upheavals the overall picture looks different. Jonathan Anderson, UBS’s chief Asia-Pacific economist, found that over the last 25 years emerging market equities have outperformed developed ones when emerging countries grew faster and underperformed when the reverse occurred. Investors should note that 25 years is a relatively short time to be drawing a conclusion from. [8 Top ETFs Since the Market’s Low.]
The takeaway here might be two things: one, don’t always assume that certain high-growth areas will always continue to be so high-growth. Protect yourself with a strategy, such as the 200-day moving average, and incorporate a stop-loss for the rough times. Two, understand the risks of emerging markets. They’re high-growth nations, sure, but in exchange for that is greater risk. [How to Follow Trends.]
For more information on the emerging markets, visit our emerging markets category.
- Vanguard Emerging Markets ETF (NYSEArca: VWO)
- iShares MSCI Emerging Markets Index (NYSEArca: EEM)
For full disclosure, Tom Lydon’s clients own shares of EEM.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.