This article is part of a regular series of thought leadership pieces from some of the more influential ETF asset managers in the money management industry. Today's article is by Bob Leggett, senior portfolio advisor at Akron, Ohio-based ValMark Advisers, which markets the "TOPS" brand of asset allocation models.
The recent underperformance of emerging market equities versus the S&P 500 Index has caused some investors to question whether they should retain any exposure to emerging markets.
This is in contrast to four years ago when the question was, “Shouldn’t I have 100 percent of my portfolio invested in EM?” Our answer, then and now, is that EM equities should typically be one of the holdings in a well-diversified portfolio.
During certain economic cycles, we look at our emerging market exposure as our research and development area. A quick way to boost short-term results is to cut the R&D budget. However, R&D is what will drive long-term success for many companies. In our portfolios, we feel that is the case; namely, that emerging markets will be a driver of long-term growth.
We have used EM exchange-traded funds for more than a decade due to favorable risk/reward characteristics relative to developed markets. These characteristics include faster earnings and dividend growth, and often lower valuations.
Specifically, we favor the Vanguard FTSE Emerging Market ETF (VWO | C-83), in part to be logically consistent. In other words, we also use the Vanguard FTSE All-World Ex-US ETF (VEU | B-98), and staying in the same index family makes controlling investment exposure and risks easier challenges to meet. Plus, who can argue with Vanguard’s low fund fees, which are undeniably good for investors?
So let’s look more closely at the emerging markets and get into why we think investors shouldn’t abandon them.
A Glorious Run
Over the past decade, higher growth expectations were supported by a number of significant factors. Those include robust demographic trends, vastly improved infrastructure, trade globalization favoring low-cost producers, greatly improved financial strength, rising demand for commodities, strengthening currencies and a trend toward business-friendly governments.
With all of that going for them, it’s no surprise that EM returns were impressive for several years. We recognize the poor returns of the past few years may signal a longer-term shift toward unfavorable risk-versus-reward for emerging markets.
Our answer to that challenge hinges on the following three observations:
- The cyclical underperformance of EM is primarily due to three factors: falling commodity prices; slower GDP growth rates; and dollar strength.
- Many of the favorable EM trends of the last decade remain in place.
- Attempts to “market-time” asset-class leadership may harm an investor’s financial results.