Historically, many institutional investors have been wary of emerging markets despite their growing role in the global economy, but the tide may be shifting, according to new research by Vontobel Asset Management.
“In many cases, [institutional investors and discretionary wealth managers’] allocations to emerging market assets have stalled in single figures as a percentage of their portfolios — below the levels that would materially capture the enhanced returns available and provide diversification benefits,” said the report. “The reasons for this range from the natural home bias of investors to concerns about elevated risk. This is now set to change.”
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Surveying 300 global institutional investors and discretionary managers, the research found institutional investors are looking to raise exposure to emerging markets equities (65 per cent) and fixed income (59 per cent) over the next five years. And the proportion of North American investors interested in emerging market equity and fixed income was even higher than their global peers, at 66 per cent per cent for both asset classes. Reasons cited for the shift include better returns (38 per cent) and more diversification (35 per cent).
“There has long been a consensus that emerging markets may offer more growth than developed markets in the years ahead, powered by structural drivers such as rapidly increasing productivity, the shift from mass production and commodities to higher-value economic activity and demographic factors such as an expanding middle class,” said the report. “But now the COVID-19 pandemic threatens to prolong the era of low-to-negative interest rates across developed economies.”
While interest in emerging markets proved strong, 35 per cent of respondents said they plan to increase allocations to these markets more slowly because of the coronavirus, 88 per cent said they’re concerned about the impacts of the pandemic when considering increasing exposure and a mere four per cent reported feeling prepared for the related risks. “It is important to separate investors’ existing anxieties about risk in emerging markets from the risk aversion they may be suffering specifically in the context of the pandemic,” noted the report.
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Investors can act to manage fears associated with emerging market investing, it said. Specifically, they may perceive emerging markets as being more volatile in aggregate, but those focused on active investing and stock selection can create a path with lower volatility.
Further, investors that feel unprepared for significant risks in emerging markets can work with specialists and put in place risk management controls to limit liabilities and manage exposures. In fact, the research found 60 per cent of investors said they have a defined risk budget for investment in emerging markets.
The coronavirus may also offer a silver lining for some emerging markets. “Some developing economies, with more rudimentary health-care systems, clearly have struggled to cope with the virus,” noted the report. “But others — led by China — have fared much better than some developed markets. One silver lining of COVID-19 is that it could force governments in emerging markets to improve health care and sanitation, enabling some countries to exit the crisis in a stronger position than they entered.”
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