EM equities have shrugged off initial fears of an uncertain future under a second Trump era, showing investors that this wide universe of companies offers opportunities that shouldn’t be overlooked.
Although many of these markets have struggled over the past decade, their longer term performance cannot be ignored, plus EM equity fundamentals are gaining momentum on the strength of upward-trending earnings estimates.
“Given their long-term resilience and considerable potential to generate alpha, we think the time is right for investors who may be under-allocated to EM equities to give them a closer look,” said Sammy Suzuki, head of EM equities at AllianceBernstein (AB).
Even for those investors who don’t have such a long time horizon, or might be wary about EM given past experiences, they can choose to allocate to a strategy that gives them confidence to stay invested.
For example, said Suzuki, some portfolios aim to offset volatility by deploying defensive strategies or by focusing on quality, profitable companies at attractive valuations.
Profitable track record
There is strong evidence to suggest a steep cost of not having enough EM exposure.
Despite market fluctuations, EM stocks have outpaced their counterparts in developed economies for well over 20 years. AB research, for example, shows that since 2001, EM equities have outperformed developed market (DM) peers by more than 3% per month slightly more frequently than they’ve underperformed by over 3% per month.
Coupled with the pitfalls of trying to time the market, Suzuki outlined the cost of being under-allocated to EM equities.
“If an investor missed just 5% of their best-performing EM months since 2001 – that’s just 15 months out of 290 – EM equities would have underperformed DM equities by 3% on an annualised basis,” he explained.
Even missing five or 10 of EM equities’ best months during the 24-year period would lead to underperformance versus DM stocks, he added. “Bottom line, it’s better to stay invested.”
Diversity and quality in EM
Yet while EM equities have historically been a good source of alpha for skillful active investors with a longer term horizon, the current environment calls for a well thought-out investment approach.
The key, said Suzuki, is to integrate policy risk within fundamental analysis, as part of a coherent and disciplined stock-selection process. “Look for companies that are less susceptible to US policies, such as firms that don’t rely on the US as a main export market, or businesses that make vital components that don’t have immediate alternatives in the US.”
There is a long list of potential stocks in these categories. Notably, the MSCI Emerging Markets Index is diverse – from large weights such as India and South Korea, to growing players like Saudi Arabia, to smaller benchmark constituents including Brazil, Greece and Poland, explained Suzuki.
In addition, companies that have already shown their ability to streamline their supply chains may also offer competitive advantages as trade tensions mount – including the many Chinese businesses that have had to adapt to several years of US tariffs by rerouting supply chains through other countries.
“There is fertile ground for selective investors to find underappreciated companies with attractive return potential [in EM],” explained Suzuki.
It ultimately requires an allocation to high-quality businesses that offer competitive advantages, pricing power and management skill. “By doing so, we think investors can calibrate their EM equity portfolios to perform well and deliver strong long-term results in a rapidly changing world,” he added.
