Columbia Threadneedle 2017 Outlook

Columbia Threadneedle

Emerging Markets Deserve a Closer LookEmerging Markets Deserve a Closer Look

Investors seeking to grow their portfolios in 2017 may be too preoccupied with potential opportunities and challenges in the U.S., such as how the election might benefit companies in the infrastructure sector, or what the rising-rate environment portends for their bond holdings. Some might say they’re missing the forest for the trees—and that forest is emerging markets.

While many U.S.-based investors consider developing countries a valuable piece of their portfolio, it’s often a small percentage of their overall allocation. They may want to rethink that strategy. Emerging markets are now 40% of the global economy—a figure that has doubled over the past 25 years.

“If you’re not in emerging markets, you’re making a pretty big bet to avoid the largest economy in the world,” says Ed Kerschner, chief portfolio strategist at Columbia Threadneedle. “It’s larger than the U.S. and larger than the Eurozone.”

Emerging markets represent not only the largest economy, but the fastest growing one. For 2017, the International Monetary Fund forecasts 4.6% annual growth for emerging markets and developing economies, compared with 2.2% for the U.S., 1.5% for the Euro area and 0.6% for Japan. Macroeconomic realities suggest those trends will continue, in part because emerging markets exhibit two of the most important factors leading to such growth. Those two factors are labor force growth—that is, a growing population—plus projected productivity growth.

Developed markets such as the U.S., Europe and Japan would have to turn back the clock to enjoy the same situation that emerging markets are in now. First, consider population growth rates: In emerging markets, population has been growing at 1% a year, while Europe’s rate is 0.3% and Japan is shrinking. For its part, the U.S. has 0.8% population growth, but roughly half of that is from immigration. (The case could be made that to limit immigration, as the incoming administration has pledged to do, could push the U.S. population rate down, closer to Europe’s, with a concomitant negative effect on GDP.)

Yet population growth is not the most important aspect of economic growth in developing countries. What drives nearly 5% GDP output in a market with 1% labor population growth? Productivity. For emerging markets, projected productivity growth is 5.1% per year, compared with developed markets’ 1.5% per year. That latter figure is unlikely to budge much, simply because developed markets already are so productive. Consider the annual output per worker in various markets:

Developed markets: $88,500

Emerging markets: $14,200

U.S.: $98,990

India: $3,550

“In the U.S., we’re so productive already that it’s hard to get huge growth in productivity. How do you boost productivity in India, Thailand, Malaysia? Put a light bulb in so you can work later in the day,” Kerschner says. “This is not a joke. Emerging markets, as they develop, worker productivity increases and that’s why their economies grow so much more rapidly.”

Investors turning their attention to emerging markets now also should consider that the story going forward is of a growing middle class. Consider the trend, according to data from the Organization for Economic Cooperation and Development (OECD):

In 2000, China represented 1% of global middle-class consumption, while India was 1% and emerging Asia was 8%. Meanwhile, Japan was 11%, the U.S. was 24% and Europe was 34%.

In 2020, China is projected to overtake the U.S. as the largest middle class in the world, and in 2024, India is expected to overtake China.

In 2050, China is projected to comprise 22% of global middle-class consumption, India 31%, emerging Asia 14%, Japan 2%, U.S. 3% and Europe 7%.

Consumers are expected to double consumption in emerging markets to the tune of $30 trillion annually by 2025. Yet the benchmark emerging-market indices focus just 20% of their total holdings on consumer-facing companies, choosing to concentrate instead on energy, basic industry, financials, telecom and other sectors.

That’s one reason why Columbia Threadneedle created its Emerging Markets Consumer ETF (ECON). “If you think about your core exposure to emerging markets, your reason for going there is the consumer,” Kerschner says. “We do ECON essentially as a core, forward-looking emerging-market exposure.”

Don’t forget that growth is not the only appeal when investors look to the developing world. Such markets also offer a strong case for diversification. Investing in Europe generally doesn’t offer much diversification for a U.S.-centric portfolio, given that the correlation between Europe and the U.S. is about 90%. That’s another way emerging markets can prove a valuable addition to investors’ portfolios.

Columbia Threadneedle is a global asset management firm that provides a broad range of actively managed investment strategies and solutions for individual, institutional and corporate clients. Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies. 

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