Why emerging markets matter

In the medium term, most things that are going to be sold will be sold to a person living in an emerging market. That's a great opportunity – from an investment perspective. Here’s how AustralianSuper is taking advantage of these opportunities, and managing the risks.

What do we mean by emerging markets?

When people talk about emerging markets, they’re talking about economies that tend to have a lower income per capita than developed economies. These economies are growing rapidly and they exhibit market volatility.

There are exceptions to the income rule. For example, countries like Qatar and the United Arab Emirates have some of the highest per capita incomes in the world, and yet are still classified as emerging markets.

AustralianSuper uses the MSCI Emerging Markets Index of 24 countries to classify emerging markets. As at 30 September 2017, AustralianSuper invested around 15.4% of the Balanced option’s international shares portfolio in emerging markets.

Dynamic growth engine

Juan Dosio, AustralianSuper’s emerging market analyst, estimates that in less than 10 years, emerging markets will go from contributing one-third to overall global growth to around 70%.

“That's why they’re important for AustralianSuper,” he explains.

“Obviously, when economies are growing there are more opportunities, because more firms are able to sell products and services to those populations.”

Pent-up demand

In the future most of the growth in the world’s population is going to come from emerging market countries, says Dosio.

As a result, along with burgeoning populations and incomes, consumption is also expected to boom.

Dosio pegs emerging-market consumption at 50 per cent of global consumption by 2025.

 

Investment benefits of emerging markets

Emerging-market equities perform two roles that make them an essential component of the AustralianSuper Balanced option.

One is their role in diversifying investment portfolios. Emerging-market equities supply something that behaves differently from other investments in AustralianSuper’s Balanced option (which also includes property, infrastructure, fixed-income and cash, Australian and global equities). This, in turn, helps to reduce the volatility of the overall portfolio.

The second advantage, Dosio says, is returns.

“A greater return is possible on that portion of the investment portfolio. Remember, that may or may not be the case. But if you invest in emerging markets, it's because you think that the combination of diversification and return are going to make sense for an investor.”

Although we have no way of knowing if the future is going to be the same as the past, Dosio says the past gives an example of what could happen.

“Let's say you invested $100 in the emerging markets index in 1988. Today, you would have $1825, which is a 1725 per cent return on your investment. If you’d put those same 100 bucks into a developed market index, you’d have done pretty well. But you would have made only $826 instead of $1825. You could have pretty much doubled those developed market returns by investing in long-term emerging markets.”

Time to pay attention

However, Dosio advises caution. Growth doesn’t necessarily translate into investment returns, he says.

“For an investor, exposure to emerging markets has to be the result of an analysis that takes into account the expected return of that specific investment, and its risk.”

“In the short to medium term, emerging markets tend to be more volatile than developed markets. More volatility means more risk, so investors with a short to medium time horizon need to be mindful of this.”

Out of the two dozen countries that make up the emerging markets there will be some that underperform the rest of the world and there will be others that do very, very well.

Dosio sums up, saying: “We can hardly predict if emerging markets, as a whole, will outperform developed markets. Investment outcomes are going to be on a country-by-country basis, on a sector-by-sector basis and, at the end of the day, it's going to be on a company-by-company basis as well. Whatever the case may be, we're going to be spending more and more time looking at emerging markets.”

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