Look to Smaller Emerging Markets to Boost Returns

New market research from State Street Global Advisors’ (SSgA) Active Emerging Markets investment team shows that the rise of emerging markets is more than just a Brazil, Russia, India and China (BRIC) story. According to the team’s research (see Chart one), since January 1997 BRICs have underperformed a group of smaller countries within the emerging world. As of March 2011, non-BRIC smaller emerging market countries outperformed BRICs by 39%. [1]

Chart one: Opportunities with Smaller Emerging Economies

The information contained above is for illustrative purposes only
Source: SSgA as at 29.03.11.
Index: 12/31/1996 = 100

Research based on SSgA’s Small Emerging Markets strategy compares the MSCI BRIC index against a group of smaller emerging countries consisting of the following markets: Chile, Colombia, Czech Republic, Egypt, Hungary, Israel, Peru, Poland, the Philippines, Thailand and Turkey.

Chris Laine, portfolio manager for active emerging market equities at SSgA comments : "Investors, while maintaining a core exposure to BRIC countries, should not close their eyes to other growth areas in the emerging world. Many of the smaller emerging and frontier economies have quietly been making investor and deserve the attention of international investors. Many of these economies offer value, growth and solid profitability."

The research also shows that with stocks trading at 11 times forward earnings, the broad emerging market asset class is not in a bubble. [2]. Laine continued : "While it is true that emerging markets no longer trade at a significant discount relative to developed markets, it is hard to say that an asset class trading at 11 times forward earnings is in a bubble. This is right in line with its seven-year average"

"Developed markets still offer the diversification, liquidity and transparency that investors require; however, if we continue to see emerging markets further develop and become more transparent, the argument to award emerging markets a premium will be compelling"

SSgA’s research also analysed the sovereign credit default swap (CDS) market and found that the market may actually be judging many developed economies to have greater sovereign credit risks than emerging. Of the 20 countries with the largest sovereign CDS spreads, only four countries are classified as emerging, while six developed countries made the list [3]

Laine explains, "On a short-term basis, emerging market equities do have a higher degree of volatility, but if we think about longer-term systemic risks, emerging markets appear to us to have more favourable characteristics. Lower government debt burdens and healthier consumers suggest that emerging markets will continue to attract capital."

"As we look to a future with strong and stable government balance sheets in emerging markets, combined with forecast GDP growth of 4-5 percent greater than the G-10 economies [4] we could see potentially high stock market returns"

He concluded, "The uptrend for emerging markets is clear and in my opinion should continue. Looking at M&A and IPO activity for the last few years, investors (and investment banks) are positioning for this growth to continue. Investors should be considering whether their current allocation to emerging markets is suitable given the risk/return trade-offs."