Three reasons to consider emerging market stocks

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Why invest in emerging market (EM) stocks? Growth potential and diversification are commonly cited benefits, yet thin positioning in many portfolios relative to the opportunity set, suggests many investors are unconvinced. Three reasons to consider a rethink:

Risk: Emerging market investments are usually associated with higher investment risk than developed market investments. Therefore, the value of these investments may be unpredictable and subject to greater variation.

EM stocks are notoriously volatile and many investors see this as a negative. Yet there are sound structural reasons to own a share in the emerging market growth story and ride out that volatility. Moreover, volatility is not synonymous with loss. Stocks move down… and up, meaning price drops can present opportunities for active investors to buy at attractive levels and enjoy the appreciation potential of an upturn.

Our analysis suggests that over the past decade, about 65% of EM stocks moved by at least 40% annually (Bloomberg, Dec 2019)*. This implies that, depending on the entry point, a large number of companies offered the prospect of a high relative return.

Skilled active managers can seek to translate volatility across the 3000+ universe into opportunities to generate above-market return.

Enhanced alpha potential as markets move

Source: BlackRock, with data from Bloomberg, Dec. 31, 2019*. EM stocks represented by the MSCI EM Index and U.S. stocks by the S&P 500 Index. The dotted lines show the average number of stocks moving 40% or more in price annually over the 10-year period (2009-2019). Indexes are unmanaged and it is not possible to invest directly in an index. Index performance is shown for illustrative purposes only.

*Note: Figures mentioned are from annual studies. Data for these sentences are reviewed annually.

We believe the current environment provides a better entry point for EM stocks relative to their developed market counterparts on a selective basis. EM valuations have narrowed the gap with their developed peers that opened up at the start of the pandemic, but they still had a 34% discount to developed peers at the end of November (Source: MSCI, 30th November 2020).

Corporate margins and return on capital are hovering near historic lows, suggesting EM stocks could have more room to run, providing investors with enhanced growth potential over time.

Risk: There can be no guarantee that the investment strategy can be successful and the value of investments may go down as well as up.

Lower valuations make for an attractive entry point

Source: BlackRock, with data from Bloomberg and MSCI as May 29, 2020. The price-to-book ratio compares a company’s market value to its book value, or the net assets of the company.

EMs failed to meet investors’ return expectations in the past decade, reinforcing under-allocations in many portfolios (Bloomberg, Nov 2020).  Yet the prior decade was very different, with EMs significantly outpacing DMs. 

While EMs make up half of the World’s GDP and 15% of total stock market capitalisation, this is not mirrored in portfolios, for instance they amount to just over 4% of the average U.S. investor portfolio, as shown below. The upshot: many investors may be missing out on the long-term potential of EM stocks.

You are very likely underallocated

¹ Source: IMF World Economic Outlook as of October 2019.

² Source: Morningstar, BlackRock Portfolio Solutions, based on 18,379 portfolios as of Dec. 31, 2019. 61% of portfolios had a dedicated allocation to a fund classified under Morningstar categories: Emerging Markets Local-Currency Bond, Emerging Markets Bond, Pacific/Asia ex-Japan Stocks, and Diversified Emerging Markets. 36% have no dedicated allocation to these categories. Note: Figures mentioned are from annual studies. Data for these sentences are reviewed annually.