Posted by Scott Keefer on Aug 29th, 2008

I wrote the following brief article on Emerging Markets for my most recent email newsletter and thought it may be of interest to the readers of OurFinanceBlogs.

Australian investors tend to have a very strong home bias towards Australian equities. We often see prospective clients seek advice and they have predominantly Australian investments. Over the past few years this has been a successful approach with the Australian market performing well compared to major overseas markets. However there has been one particular area of international markets that has had strong recent performance, namely Emerging Markets. So what do we mean by emerging markets?The term is used to describe business and investment activity in industrialising or emerging regions of the world. From an economics perspective, these economies are said to be in a transitional phase between developing and developed status. They are countries that have begun to open up their economies to the world. The classification of emerging markets is not an exact science and as such there is not a definitive list of countries included in this definition. However, to put some names to these economies, the top 4 markets in this space are generally referred to as the BRIC economies – Brazil, Russia, India and China. If you have had any exposure to the international financial media you would quickly identify that these are some of the fastest growing economies in the world – 2007 growth results reported by the International Monetary Fund saw all four with strong performances – Brazil (5.4%), Russia (8.1%), India (9.2%), China (11.4%).Growth in the domestic economy is nice but what share market investors are looking for is growth in the value of shares within these economies. The MSCI – Emerging Markets Index, is the index which is widely used as a benchmark for returns. The past 12 months have seen a decline of 21.48% for the year to date or 6.91% for the year to the 15^th August 2008. However, even with this particularly poor year included, 3 year returns to the 31^st July have been 16.2% and 5 year returns 19.7%. In comparison the MSCI World Index ex Australia has seen returns of 1.8% over 3 years and 6.3% over 5 years while the ASX200 has seen returns of 8.7% over 3 years and 14.44% over 5 years. This places the Emerging Market returns as favourable over these periods of time.However, as with all major investment markets, to capture higher returns there is a trade-off between risk and return. The greater the risk, the greater the expected return. Emerging Markets are no different and have experienced significant downturns. Consider the Asian and South American monetary crisis in the late 90s. These economies also have some regulatory issues that need to be considered before investing, for instance the strict monetary and political controls in China and regulatory issues in Russia.So what is our stance on investing in Emerging Markets?We invest in Emerging Markets to provide an extra risk – extra return premium for our investors. Investing in Emerging Markets also provides an extra level of diversification to smooth out volatility. We invest in these markets by using an index style approach. Not picking winners (or losers) but holding a wide spread of investments across emerging markets. This keeps the cost of investing low and provides Our preferred fund, Dimensional Emerging Markets Trust, holds shares in companies listed in Argentina, Brazil, Chile, China, Czech Republic, Hungary, India, Indonesia, Israel, Malaysia, Mexico, Philippines, Poland, South Africa, South Korea, Taiwan, Thailand, and Turkey. (You will note that it does not hold assets in Russia mainly due to the regulatory controls in place in Russia.) In a standard portfolio, an investor would have an exposure of about 5.5% of their growth assets in emerging markets.

Regards,
Scott Keefer

www.acleardirection.com.au

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