Emerging markets have outgrown the “emerging” label. They now play a more integral role in the global economy, so they’ve become more complex. But many investors still take a traditional piecemeal approach to these markets, which fails to deliver the best results. A multi-asset, holistic approach is a better solution.
Despite the flight from emerging markets this spring and the way their equities have underperformed developed market stocks for the past three years, investors that stayed the course in emerging equities over the last decade have been well rewarded. In the 10 years ending June 28, 2013, the benchmark MSCI Emerging Markets Index returned 10.8% annually for the unhedged Canadian dollar investor.
Today’s investors face a more sophisticated emerging markets landscape. Issuance of both equity and debt has burgeoned, and local currency debt markets have become a key investment option. Myriad choices— both between and within asset classes— now exist, and strategies such as short-selling are more available.
Piecemeal approach
Although there are now more choices, many investors still focus on binary options such as equity or debt, active or passive, and long-only or long-short. Often, they fail to fully consider fundamental return drivers such as the effect of currency movements, index methodologies, inter-asset class correlations and globalization forces.
This approach might deliver suboptimal results, leading to unintended risk exposures. This is particularly true when using multiple asset managers who may not possess security-level details of an investor’s overall emerging markets portfolio. The shortcomings of a nonintegrated approach are becoming apparent to many investors that recently saw nominally well-diversified assets trade in lockstep, given their underlying sensitivities to currency movements or interest rate expectations.
Multi-asset solution
To mitigate the limitations of the piecemeal approach, some investors are now embracing a multi-asset approach that combines exposure to equities, fixed income, currencies and real assets (such as real estate and infrastructure) into one vehicle. This approach can take several forms but usually involves greater use of medium-term and tactical asset allocation views, combined with rigorous risk management. In volatile and uncertain markets—where even “safe” fixed income assets are subject to potential shocks—asset allocation plays a key role in driving returns. Multi-asset solutions, which can mitigate exposure to unrewarded risks, may therefore be optimal.
Looking at the traditional sources of risk in a 60/40 portfolio, a large proportion of risk is associated with emerging market equities. A multi-asset exposure to emerging economies would mitigate this concentration of risk over the long run through an allocation that spreads risk across several asset classes that perform well during different periods.
Multi-asset funds have long been a solution for developed market investors seeking competitive returns from a diversified portfolio with less risk than a traditional equity portfolio. But recently, they have become manageable in emerging economies, too, where new real asset classes have opened up, and the stock and bond markets have grown deeper and more liquid.
The beauty of the holistic solution is that it mitigates the concentration of risk in a way that the traditional approach cannot. Once investors recognize its benefits, this approach will likely become more widespread over time.
Eric Léveillé is head of the Canadian institutional business with BlackRock Asset Management Canada Ltd.
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