STA Weekly Report – Avoiding Home Bias Through Emerging Market Exposure
Written by Luke Patterson | Wednesday, May 15th, 2019
INSIDE THIS EDITION: Avoiding Home Bias Through Emerging Market Exposure STA Money Hour – Investing 101 with Kids Portfolio Stress Test 401k Plan Manager
Most investors in public stocks have heard of emerging markets and the issues they can experience from time – out of control sovereign debt, currency fluctuations, out of control inflation, and political turmoil.
Just look at the chart below. While it plots the U.S. Dollar Index, it also shows the many times since the 1960’s that emerging market economies have experienced crisis.
It is no wonder why so many investors are inclined to shun emerging market investments. Not only are they often associated with crisis, but they also tend to feel unfamiliar compared to investments domiciled in the United States. This leads to investors having a home-country bias in their portfolios, which we would argue is a dangerous proposition from two points of view – diversification and future expected return.
There are approximately 24 countries that are classified as
emerging markets. They cover the spectrum in terms of geographic location and
size. However, the majority of these markets are gradually transitioning from
an agrarian economic base to one dominated by manufacturing. The shift has big
implications across all markets, but none is greater than the emergence of a
middle class in these countries.
As the middle class grows, it typically means higher wages
and more consumption in the emerging world. The chart below shows the impact of
the growing middle class on consumption in a select number of developed and
emerging markets. The standouts are India and China which by 2020 are forecast
to see consumption by the middle class grow considerably.
There is also a growing need for services in emerging
markets that will help sustain economic growth and increasing levels of
prosperity. From an investors point of view, this is a good thing as it
provides fertile ground for finding investment opportunities across sectors,
allowing for better diversification.
The U.S. makes up a relatively small percentage of the
world’s economy. As a result, ignoring international and emerging markets
eliminates a large swath of the available opportunity set and keeps investors
from capitalizing on nearly 75% of the world’s economic output.
With a wider opportunity set and higher expected returns
going forward, investors would be wise to maintain an exposure to emerging
markets. However, because these economies are in various stages of their growth
and development they each present their own set of risks. It is why to be
invested in emerging markets requires sound risk management and discipline that
allows for volatility within a range, but not allow a position to decline so
much within a portfolio that it is hard to recover from.
China as a case study
China is the biggest and best example of the impact that
economic transitions can make. The Chinese economy over the last decade has
seen a boom in the service sector, migration toward cities and the increase of
economic mobility. Of course, economic and political reforms have played a
role, but the natural demand for services and new ways of doing business have
intensified the rate of change and the overall access to investments in this
Investors have as a result enjoyed solid investment results
for the better part of two decades. However, to get those results, they have at
times had to accept higher levels of volatility.
While not every emerging market will have the
same return profile as China has had, it does serve up a useful reminder:
Emerging markets can perform well over time but over periods can experience
high levels of volatility. For investors, it is thus very important to keep in
mind that accepting higher volatility is oftentimes the price you pay for that
higher return profile.
Andrei Costas, Senior
Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment
Analyst (Fixed Income Strategies)
Investing 101 with Kids Friday, May 10th, 2019
Luke Patterson hosts a very special STA Money Hour, as we welcomed guest hosts Jacob (age 10) and Jackson (age 7) to talk about the basics of a good financial plan. Luke Patterson chatted with the boys about starting to save, and the earlier the better. Luke explained the power of compounding interest and having goals when it comes to your money.
STA Wealth Management – Portfolio Stress Test By Scott Bishop, MBA, CPA/PFS, CFP® Executive VP of Financial Planning
Although the markets have had a nice run since bottoming in March of 2009 (after the 2008 Global Crisis – see chart below), many are feeling that they are due for a correction based on time, valuations, “headline” risks, etc.
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