Emerging markets are a huge contributor to global growth – but for investors looking to capture that growth, public equity markets might not be the best route. A new paper from University of Toronto researchers Redouane Elkamhi and Joon Bae shows that relying on public equity indices for global diversification leads to significantly muted gains over time. This is mainly due to the fact that while many emerging market economies are growing rapidly, their public equity markets remain relatively small and unable to capture the diversification gains.
Elkahmi and Bae find a way to get around this by investing solely in publicly-traded, export-oriented firms in developed markets. While these firms aren’t located in emerging markets, they are active in these economies and, from the standpoint of investors, they deliver portfolio diversification benefits that aren’t available through emerging market equity indices.
Our emerging economy portfolios deliver factor-adjusted returns above 7% annually and generate Sharpe ratios exceeding those of equity indices of both developed and emerging markets.
The results suggest one way to enhance global diversification and make the most of the emerging markets growth story, beyond what can be found on public markets.
Elkahmi and Bae will present their paper this weekend at the Northern Finance Association Conference in Mont Tremblant. You can view it here.