Most U.S. investors are heavily weighted toward domestic stocks, leaving many underallocated to international stocks and exchange traded funds that track emerging market growth.
Investors are missing out on the growth opportunity presented by the emerging markets. BlackRock points out that the average investor is underweight the emerging markets, allocating around 5% of an investment portfolio to developing countries when a 18% weighting to EMs is more appropriate.
According to BlackRock, emerging markets only make up 12% of global stock market capitalization, but developing economies account for 51% of global GDP, writes Mamta Badkar for Business Insider.
“For investors who want to develop their portfolios, the developing world is an unmatched source of potential,” BlackRock analysts said in the article.
However, investors can’t rely on GDP growth as an indicator for high returns.
“Investors may need to fundamentally rethink what it means to be an investor in emerging markets,” BlackRock said. “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.”
Market-capitalization could diminish investor’s exposure to the emerging markets.
“The MSCI EM Index represents only 4% of the stocks listed in the emerging world,” BlackRock added. “The MSCI EM Small Cap Index covers an additional 9%.”
Moreover, due to our current globalized economy, investors even find emerging market exposure through indirect methods.
“Many companies located in the developed world derive a significant portion of their revenue from the emerging world, while the reverse holds true for many companies headquartered in EMs,” the analysts said. “As companies expand their footprint globally, their revenues become more diversified. You need not invest in an EM-domiciled country to benefit from EM growth.”
The iShares MSCI Emerging Markets ETF (NYSEArca: EEM) and the Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO) are the two largest emerging market ETFs on the market. Additionally, investors can consider a small-cap oriented ETF like the WisdomTree Emerging Markets SmallCap Dividend Fund (NYSEArca: DGS).
On Tuesday, the iShares EEM ETF finally broke out of its six day losing streak as the Chinese government revealed an expanding manufacturing sector, bolstering the outlook on global growth, Bloomberg reports.
“Emerging markets are still a source of global growth,” Walter “Bucky” Hellwig, a manager at BB&T Wealth Management, said in the Bloomberg article. Developing market stocks “were so oversold that some money came in to take advantage of the bounce.”
For more information on developing economies, visit our emerging markets category.
Max Chen contributed to this article.
Full disclosure: Tom Lydon’s clients own EEM.