Developing economies have played second fiddle to developed market over the past few years, with U.S. equities leading the charge. However, investors are finally beginning to take a closer look at emerging market stocks and exchange traded funds as many search for cheap opportunities.
“Here at Deutsche Asset Management, we believe that the time is ripe for investors to rekindle their relationship with emerging markets,” Robert Bush, ETF Strategist at Deutsche Asset Management, said in a note. “At our most recent Chief Investment Office (CIO) day, we moved to an overweight on the region and, fortunately, we allowed our heads to rule our hearts.”
Specifically, Bush pointed to a number of contributing factors that helped support their overweight positioning. For instance, the developing economies are showing macro stabilization where gross domestic produce and commodity prices that support their economies have stabilized. China, the second largest economy in the world, is also revealing signs of improving industrial production, steady infrastructure spending and a more stable yuan currency.
The global economy is also on the path of growth, which has helped support increased exports out of the developing countries. Bush and the Deutsche team see outbound trade rising faster than imports in a number of large exporting countries, such as South Korea, Taiwan, Thailand and Russia.
Earnings growth is also a major contributing factor as Deutsche anticipates earnings to grow at more than 10% over the course of the next year in the benchmark MSCI Emerging Markets Index.
Discounted valuations, especially in an environment where U.S. equities are trading near record levels, provide a relatively attractive opportunity for investors. Even after the strong start to this year, current price-to-earnings ratio of MSCI EM is around 15.1, compared to the 22.2 for MSCI USA Index.
Monetary policies in developing economies also remain supportive as many central banks are seeking looser policies instead of tightening, which may support risk assets like emerging equities by encouraging local money to seek higher rates of return. While some may be concerned about devaualtion in emerging currencies compared to the U.S. dollar, rapid devaluation has not materialized in the post U.S. election environment.
Lastly, Deutsche also showed that emerging markets have exhibited lower volatility over the past 16 years and provide relatively low correlation to U.S. stocks over time, which may be good reasons to include EM as part of a diversified international equity portfolio.
Investors have a number of emerging market ETF options to choose from, including those that track benchmark indices like the MSCI Emerging Market Index. However, Deutsche Asset Management has come out with a number of alternative or smart beta EM options that could provide enhanced returns and diminish potential risks.
For instance, the Deutsche X-trackers MSCI Emerging Markets Hedged Equity Fund (NYSEArca: DBEM) targets the emerging markets, but diminish the negative effects of depreciating emerging currencies on U.S. dollar-denominated portfolio returns.
The Deutsche X-trackers MSCI Emerging Markets High Dividend Yield Hedged Equity ETF (NYSEArca: HDEE) also provides a currency-hedged option for emerging market exposure, but HDEE focuses on high dividend yielding assets for those income-minded investors.
The Deutsche X-trackers FTSE Emerging Comprehensive Factor ETF (NYSEArca: DEMG) help limit correlation and diversify a portfolio to better handle changing conditions over longer periods by screening for historically proven factors like quality, value, momentum, low volatility and size.
For more on smart beta ETFs, visit our Smart Beta Channel.