Following a year in 2011 that saw emerging markets drop by 20%, and with a slowdown in China looming, some investors may be tempted to withdraw their capital from emerging economies. Yet, the same question that has driven successful investment in emerging economies for the last fifteen years confronts investors today: do you want to invest in economies growing at 1-2% with debt loads as large as their GDP's or ones growing at 6-8% with minimal debt? If you answered the latter, emerging markets should remain a significant part of your portfolio.
Looking at The Washington Times chart below that compares forecasts of the top ten world economies' GDP and national debt growth rates for 2012, China and India are the only countries boasting a GDP growth rate larger than the growth rate of their national debt. Next closest to achieving a GDP-to-debt balance? Brazil. Meanwhile, the developed economies of the world continue to generate lackluster growth amidst rising debt loads.
Investors, of course, have to balance consistency with growth, and the volatility inherent to the emerging economies makes for increased risk in the short-term. But we believe this short-term risk is more than offset by the high probability of long-term market-beating returns.
Take 2011 as an example. Emerging market equities dropped 20% under the weight of the debt crisis in Europe, illustrated by the chart below that uses iShares' MSCI Emerging Markets ETF (EEM) as a proxy for the index:
Compare emerging market performance to the nearly flat finish for the U.S. market. Since emerging economies consistently record GDP growth rates that run laps around developed world growth, opportunistic investors saw an attractive entry point at the end of 2011 and have been rewarded handsomely during the first two and a half months of 2012:
Bottom line: invest where you see the greatest potential for growth. Timing, of course, can play a significant role in the relative success of any investment, but we recommend a base level of exposure to the emerging economies. Assuming the existence of this foundational exposure in a portfolio, we encourage investors to accumulate on dips. Look no further for potential windows of opportunities than recent talk of a "hard landing" in China or omnipresent concerns over rising inflation. If you trust in the resilience of these markets and buy into the dips, their volatility becomes your ally.
General Emerging Markets Exposure
For general exposure, you may choose any number of actively managed and broadly exposed emerging market funds, or you can deploy index tracking ETF's like Vanguard's Emerging Market ETF (VWO) or the iShares MSCI Emerging Markets ETF used in our chart analysis. For slightly less volatility and higher income, emerging market dividend ETF's like SPDR's S&P Emerging Markets Dividend (EDIV), WisdomTree's Emerging Markets Equity Income (DEM), or the iShares Emerging Markets Dividend Index (DVYE) are options as well.
Asia ex Japan
For Asia ex Japan exposure, which we believe warrants its own controlled weighting in your portfolio, we recommend choosing Matthews Pacific Tiger (MIPTX,MAPTX) and Matthews Asia Small Companies (MSMLX). These Matthews funds are best of breed in our view, with excellent track records of outperformance and reasonable fees. If you prefer the ETF route, iShares MSCI All Country Asia ex Japan (AAXJ) is the way to go.
While Matthews Pacific Tiger includes Indian holdings, pure-plays on India might be PowerShares India Portfolio (PIN), WisdomTree India Earnings Fund (EPI), or iShares S&P India Nifty 50 Index (INDY).