Investors are turning to emerging markets

David Prosser explains the options in this exciting sector.

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Is it time to embrace emerging markets – the stock markets of developing economies around the world? Many investors appear to think so, with one important caveat.

So far this year, reports JPMorgan, investors have put more than $10 billion into “ex-China” emerging markets funds. By which the asset manager means funds that invest in emerging markets worldwide but don’t hold any money in China, which is the biggest emerging market of all.

There are a couple of reasons people are choosing to avoid China right now. First, the country’s stock market has suffered all sorts of problems amid an economic slowdown and tensions with the West (though it has rallied strongly in recent months). Second, and more philosophically, many investors now consider China to be too large a market to hold in a generalised emerging markets fund; they fear other promising markets could be crowded out. China, after all, now accounts for a quarter of the MSCI’s global emerging markets index – and, at times, it has accounted for 40% of the benchmark.

Still, the debate about China aside, the current conversation about emerging markets is fascinating – and funds that do include China exposure have also seen significant inflows this year. After several years in which investors worldwide have largely been “risk-off”, preferring a more conservative approach, risk appetite is returning. “Risk-on” investors have been buoyed by interest rate cuts and the improving prospects for economic growth.

“Given that emerging markets have been out of favour for a period, it’s also worth reminding ourselves of the fundamental attractions of investing in them. Effectively, you’re buying into companies based in countries and regions with prospects for more rapid growth than in the West.”

David Prosser

David Prosser

In that context, it was fascinating to read an analysis from Gabriel Sacks, an emerging markets specialist at asset manager abrdn, published by Citywire in recent days. Sacks made the case for considering emerging markets on three separate bases: the governance reforms many developing economies have introduced in recent times, the exposure of many of these economies to the technology revolution (and particularly artificial intelligence), and the fair wind coming from the US economy as it loosens monetary policy.

Given that emerging markets have been out of favour for a period, it’s also worth reminding ourselves of the fundamental attractions of investing in them. Effectively, you’re buying into companies based in countries and regions with prospects for more rapid growth than in the West. These businesses often benefit from demographic factors – developing economies often have young, fast-growing populations, with rising income levels promising to boost demand.

With that profile comes additional risk. Emerging market equities do tend to produce more ups and downs. They’re vulnerable to both domestic drivers of volatility and to the headwinds that the global economy can throw up. Investors typically choose to allocate only a small percentage of their total portfolio to these markets.

As with other volatile sectors, investment trusts have particular attractive qualities when it comes to choosing a fund for emerging market exposure. The structure of an investment trust – its closed-ended status – provides protection at times of heightened stress. When investors choose to withdraw money en masse, investment trusts can cope much better than their open-ended counterparts.

If that makes sense, the investment trust industry offers several different ways to get into these markets. The [insert link here: Compare investment companies | The AIC] Global Emerging Markets sector includes around a dozen funds that mostly offer exposure spread across markets worldwide. But there are also separate sectors for funds specialising in Latin America, in China and in India. How you approach the China question is up to you. But the generalist emerging markets investment trusts all publish details of their asset allocation policies and their current portfolio weightings. This will enable you to put your preferred approach into practice – and the China sector provides a choice of several funds offering concentrated exposure if that’s what you decide you want.