It’s intriguing that even though emerging markets like India have enormous opportunities, the asset allocation to this part of a client portfolio is often relatively low.
NRI Adviser sought views from a cross-section of investment advisers in the UAE and found that each offers varying reasons.
Navin Nihalani, founder and chief executive of Dubai-based Compass Insurance Brokers, attributes it to a disappointing performance by emerging markets.
“After a period of market decline, investors sometimes consider to lower the weight of emerging markets in their portfolio. One of the reasons is that emerging markets have majorly disappointed in recent years. Also, major economic and socio-political risk factors make investors wary,” he said.
Investors are wary of a lack of clear regulation, foreign exchange rate risk, poor corporate governance, an absence of liquidity and ‘the risk of the unknown’ in emerging markets.
“History has shown that in the early days of emerging markets investing, trouble in one country could quickly spill over to another and this adds to contagion risk to emerging markets. We are also entering a high US interest rate environment which is usually a bad thing for emerging markets,” he said.
Most high net worth clients are beyond their value creation phase and hence private bankers and financial advisers tend to focus on preserving their wealth rather than take risks. Most clients are not interested in taking huge bets with their money, he said.
Valuations are ‘tempting’
Aju Unnikrishnan, general manager at Dubai-based auditing and investment advisory firm FRG, agrees that exposure to emerging markets has been minimal in spite of the fact that they have outperformed the US and other developed markets in the past two years as investor sentiment turned strongly bullish on the asset class.
For the same reason, Aju says, long-term investors should consider more equity allocation to emerging markets which are diverse, yet dominated by a few large countries. China represents over 38% of the market capitalisation of emerging markets, with India and South Korea coming in second and third.
He vouches for India and China for the simple reason that valuations are tempting in spite of the recent sell-off. The relative size of their economies and stock markets make them bellwethers for the entire asset class, though there have been some temporary hiccups.
India, the world’s third-largest economy measured by gross domestic product based on purchasing power parity, has seen its currency depreciate in the face of mounting costs to import oil.
Not the best decade of returns
Aju concurs that the emerging markets as a whole have not had the best decade of returns. Yet, historically this is a good category for a portion of a client’s portfolio.
The emerging markets as a whole currently have a favourable forward price to earnings ratio. The earnings growth prospects for the MSCI Emerging Markets IMI compare favourably with those of the S&P 500 Index. On a long-term basis earnings growth for emerging markets should be around 10% and long-term earnings growth for the S&P 500 should be around 6%.
Earnings can be volatile
Cherian Kuriakose, senior consultant with Ren & Chery Consultants, Dubai, cautions that earnings in emerging markets can be quite volatile. “Investment in emerging markets needs to be long-term and an investor needs to have a higher risk tolerance and an ability to ride out the greater volatility inherent in the emerging equity markets.”
Cherian favours advanced markets but would advocate diversification and regular rebalancing between the S&P 500 and emerging markets. “It’s a fact that volatility has risen across most asset classes this year as central banks in the US, Europe and the UK have started to withdraw the extraordinary measures to support financial markets that were introduced in response to the 2007-08 financial crisis. The increase in volatility has clouded the near-term outlook.”
However, expectations for returns from US Treasuries, investment grade corporates and high-yield bonds have all improved as increases in US interest rates, already introduced by the Federal Reserve, have created a better starting pricing point for investors. Long-dated Treasuries will deliver annualised returns of 3.25% over the next decade, up from 2.5% in last year’s analysis.
Navin recommends clients to have a minimum 10% allocation to emerging markets. “We believe the long-term potential for capital growth from large populations and fast-growing companies continue to offer compelling arguments for some exposure to the sector in a balanced portfolio, despite the high volatility.”
