Recently I’ve experienced what it’s like to sit on the sidelines instead of being in the race. As an avid runner, I’ve rarely missed a day of hitting the pavement. So you can imagine my despair when an injury recently laid me up for eight weeks. In anticipation of my next marathon in a far off place, Africa to be specific, I thought of investors sitting out their own race in emerging market (EM) stocks.

While it’s true that the asset class has taken a bit of a beating in the past few years – largely due to the “taper tantrum” and growing concerns about the state of China’s economic health (more on this in an upcoming Blog post) – the race is on. Year to date, broad EMs are outperforming their developed market counterparts in the U.S. and beyond. And though EM inflows have slowed down a bit from early summer highs amid concerns about rising U.S. rates, many investors continue to embrace EMs.

Emerging markets can be an important source of growth potential and diversification for many investors’ portfolios, and I fear many people are significantly under-allocated. They are sitting out the race.

As I discussed last time, there are a number of reasons my colleagues and I are convinced we’re at an attractive re-entry point for EMs even after the recent rally. I’ll highlight three of them here:

  • EM stocks are cheap compared to developed markets. Relative price-to-book valuations are at the most attractive levels we’ve seen in 10 years. As developed market stock indices have been hitting all-time highs, EMs are still off 24% from their peak – making them a comparative bargain.
  • Signs of improvement are boosting stock prices. The Chinese government’s stimulus appears to be having a stabilizing effect in that country, while market-friendly elections in India and Indonesia have triggered stock rallies in both markets. These events have started to whet investors’ EM appetites. In addition, the rate outlook for EM countries generally remains benign.
  • The investor tide is beginning to turn. More recently, sell side analysts have been reversing their bearish EM views, with about half upgrading back to neutral or overweight. And as EM performance has turned around, flows have followed, with a positive showing for the past six months.

Stepping Back in with ETFs

While my colleagues and I generally advocate a selective approach to EM given diverging fundamentals and policy outlooks among countries, and we particularly like EM Asia, we know that many investors want to take a broader approach.

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