Emerging markets could provide real diversification

Emerging Markets

Investors have generally been exhorted to ‘look internationally’ to compensate for domestic uncertainty, but is that really the best option? After all, given that the pound has slumped, investors are paying a lot more for, say, US or European assets than they were just a few short months ago.

Looking internationally has a number of notable advantages. Firstly, it avoids all that nasty Brexit related uncertainty. The UK may have got rid of much of its political uncertainty, but there is still no clear line on the shape Brexit will take. This means the outlook for UK companies is still unclear. From a risk management perspective, it looks sensible to considerable alternative markets, where the risks are different.

This is particularly true for income. While the weaker pound may have given a boost to UK dividends in the short-term, UK dividends have proved vulnerable this year, with a number of high profile cuts and this phenomenon may continue if the economic environment worsens considerably. Those on the hunt for predictable income need to ensure their exposure is sufficiently diversified.

However, investing globally is not a panacea. Lots of international stocks are vulnerable to same forces that govern UK stocks – particularly in related markets such as Continental Europe – and as, such, may not provide the diversification that people are seeking. Plus, they are paying a higher price for them thanks to sterling weakness.

If investors are going to look globally, they need proper diversification. With this in mind, it could be a time to reconsider emerging markets. With the prospect of Federal Reserve rate rises removed, emerging markets have started to be assessed on their merits once again and have seen some strong recent performance. Over the past month, many emerging markets have seen double-digit gains, with funds in the IA China/Greater China sector showing an average rise of 18.5%.

Of course, investors may conclude that they have missed the boat, but emerging markets have five years of underperformance to reverse. NN Investment Partners recently pointed out that for the first time since 2014, the average growth momentum in the emerging world has turned positive. Growth rates are no longer falling, while improvements in capital flows have resulted in stronger exchange rates and lower interest rates.

There is a growing realisation that the developed world is in a bit of a mess, politically and economically. There are still issues in emerging markets, but with China’s growth stabilising and debt levels lower, the don’t look nearly as bad in comparison.