Emerging markets are making an overdue comeback

Such underperformance is disappointing, particularly since it extends a period of mediocre returns that goes back 15 years or so.

The long-term case for emerging markets feels as strong as ever. These are countries that, generally speaking, have younger populations, are at an earlier stage in their economic development and therefore have the potential to grow more quickly – and to deliver stronger returns. The Association of Investment Companies (AIC) spoke to some Asian emerging markets trust managers last month and they make a convincing case.

In recent times, however, many of these countries have suffered from the strength of the US dollar, to which they’re often exposed through high levels of dollar-denominated debt. Global economic and political disruption has also been unhelpful, prompting investors to steer clear of assets perceived as riskier. Difficulties in specific markets – notably China – have also dragged down returns.

Some of these problems are now finally beginning to unwind. Most significantly, the dollar has weakened significantly this year – and that looks set to continue as the US moves into a phase of reducing interest rates. There are also positive factors to highlight – several developing countries are manufacturing centres for the chips powering the artificial intelligence boom, for example.

It’s also worth noting that despite this year’s outsized gains, emerging market stocks still look attractively priced in relative terms. The Financial Times noted this week that constituents of the MSCI Emerging Markets benchmark are priced, on average, at about 14 times their forecast earnings for the next year, compared with about 23 times for the typical US stock.

None of which is to suggest investors should plunge headlong into emerging markets, which do carry additional risk. However, in a broad-based portfolio aimed at delivering long-term growth, there will very often be a place for emerging market holdings – after all, these markets include some of the world’s largest and most dynamic economies, including India and China.

A collective investment vehicle run by a professional manager with specialist emerging market skills and experience will be the best way to secure exposure for the vast majority of investors. While it’s possible to invest directly in some of these markets, most investors lack the expertise to navigate the challenges and opportunities on the ground.

To this end, many investment professionals argue that the structure of investment trusts makes them a better option for emerging markets exposure than open-ended funds. The illiquidity and volatility of some emerging markets can cause problems for managers of open-ended vehicles, who are managing inflows and outflows from their funds according to investor demand, which can also be changeable. Investment trusts, by contrast, are insulated from this danger by their closed-ended structure, enabling them to take a long-term view.

One recent study from Trustnet supports this idea. It looked at five-year returns from comparable funds in 18 different sectors; investment trusts delivered stronger returns than open-ended funds in 12 of those sectors, but this outperformance was greater in the Global Emerging Markets sector than any other.

Past performance, as we know, is no guide to the future, but investment trusts do have a long-term track record of successful investment in emerging markets – both through global funds investing in multiple markets and more specialist vehicles focused on individual countries. Their time to shine – and deliver on the theoretical promise of young, early-stage economies – may finally be dawning.