We have always encouraged our clients to have well diversified portfolios (often to the point where you may tire of hearing us say this!). It is possible to reduce your overall risk by adding asset classes that by themselves are riskier to the mix. Emerging market exposure is one area that we generally suggest our clients have exposure in their investment portfolios. This can take the shape of Emerging Market Equities (EME) or Emerging Market Debt (EMD).
Having some of your assets in international markets is becoming more important as the US becomes a smaller part of the world economy. Currently, the US is about 40% of world stock market value. As you are aware, developed markets have gone through a significant downturn in 2008 and 2009 and continue to struggle in many areas around the globe. Emerging markets currently make up around 12% of world market cap but are projected to make up 50% of the global GDP by 2017.
Emerging market GDP growth has outpaced the developed markets over the past 10 years. More importantly, when you look at debt to GDP ratio, it is typically much lower in emerging markets than it is in the developed world. Emerging markets went through their own “economic crisis” in the late 1990’s, but leverage has fallen since then and profitability has improved. While these markets certainly tend to be more volatile than developed markets, the outlook for future growth is good.
Most investors remain under weighted to emerging markets. In the EME area, you might gain exposure through your multinational corporations whose profits from emerging markets are growing quickly. International equity mutual funds also typically have some allocation to EME. Finally, you can chose to specifically allocate some of your investments to funds that focus on EME. Typically, fixed income mutual funds do not have much exposure to EMD. It may make sense to add a fund that invests in this area to your portfolio. There are three sectors of EME – soverign debt, local currency debt, and corporate debt. The latter two are the areas that are most common now and there are a number of good mutual fund choices to gain exposure here.
The importance of a well diversified portfolio that invests across the globe cannot be stressed enough in these challenging economic times. Having some small exposure to EME and EMD can help reduce the overall risk of the portfolio and will also hopefully enhance returns in the future. These two areas also tend to complement each other nicely. Let us know if we can help you consider this aspect of your personal financial situation.
To download a Word version of this article, click here.