Why investors see better returns from going more global

Home bias – investors’ tendency to buy assets in places they are familiar with – has a lot to answer for.

It is natural and understandable that people are generally more comfortable buying what they know – or think they know. But by doing so they can miss out on significant opportunities or, worse, suffer bigger losses because of insufficient geographic diversification.

That is why smart investors are generally diversified across different asset classes and countries. A recent international survey by EquitiesFirst in collaboration with Institutional Investor’s Custom Research Lab, revealed near-universal agreement among some 300 investment decision-makers that their financial institutions would benefit from exposure to a broader range of equity markets.

According to the study, the overriding rationale for taking a global approach to buying active, alpha-seeking equity opportunities is that equity markets are becoming ever more interconnected. Global diversification can help reduce the concentration risk of investing in one region, potentially helping to smooth out portfolio volatility.

Upside potential

It can also encourage investors to pay more attention to emerging markets, which attract far less capital than developed ones despite offering much greater upside potential, especially over the long term.

While emerging countries now account for about 40% of global GDP and have been responsible for almost two-thirds of global growth over the past two decades,^[1] their stock markets account for just a quarter of the world’s market capitalization.^[2] That narrowed for much of the past decade, when emerging market equities outperformed those of developing countries, except in 2022, when owing largely to lockdowns in China, they underperformed.^[3]

With China’s abrupt reopening coming earlier than expected in late 2022, emerging country equity benchmarks look set to rebound strongly this year on the back of improved near-term prospects and long-term demographic trends. Even with high interest rates and the Ukraine war dragging on global markets, emerging-country GDP growth rate will hit 3.9% in 2023, around the same rate as last year, largely driven by developing Asia, predicts the IMF. For advanced economies, meanwhile, the figure will plunge to 1.3% from 2.7% in 2022.^[4]

On challenging ground

Of course, broad measures like GDP growth and global emerging equity indices mask the large and diverse challenges that Asia and other developing markets pose investors.

Compared to developed economies, emerging markets are typically less economically and politically stable, have lower standards of governance and are generally less liquid and transparent and harder to access.^[5] And within the emerging market universe, countries are far from homogeneous, with hugely varying growth rates, political systems and corporate landscapes – hence the opportunities and risks they present diverge widely.

For much the same reasons, however, emerging market stocks have the potential to generate big returns for savvy, well-informed and selective investors.

Emerging countries’ standards of corporate reporting, auditing and governance may lag those of developed markets, but the situation is improving. Corporate governance issues and the quality and availability of performance data have become less formidable barriers to investing in emerging markets, agreed almost all respondents to the Equities First survey.

Several investment decision-makers interviewed for the study also stressed that further improvements are likely in the coming years, with emerging markets appearing on more investors’ radars and competition for international capital heating up. If companies in emerging markets wish to attract foreign investors, they will have to improve their transparency, reporting and compliance.

Emerging tailwinds

There is good reason to expect emerging markets in four key categories to perform strongly for the foreseeable future, say analysts at investment bank Morgan Stanley.^[6]

For one thing, certain countries are set to prosper from their growth as manufacturing hubs. They are largely concentrated in Southeast Asia and Eastern Europe, with Vietnam and Poland standing out as notable examples.^[7]

Some nations, meanwhile, have received an economic boost from the revival in commodity prices and have a critical role to play in supplying the metals and minerals necessary for the energy transition – the likes of Brazil, Chile, Indonesia and Russia.^[8]

A third category identified by Morgan Stanley contains developing countries that were forced to undertake painful economic reforms during the Covid pandemic but, as a result, are now set to grow more sustainably in coming years. These include India and Indonesia.^[9]

Finally, certain markets seem especially well placed to benefit from accelerating digital transformation – again, fuelled by coronavirus lockdowns – and with the potential to create local versions of US and Chinese tech giants. This trend looks set to have a particular impact across Latin America, East Asia and Africa.^[10]

For now, assets in many of these countries appear cheap compared to those in developed markets. Indeed many investors argue that emerging market stocks are heavily mispriced and under-owned – even taking into account the higher risks they entail – and that current valuations could be some of the most attractive ever.^[11]

Investors in need of capital to pursue such opportunities may wish to consider securities-backed financing. By using equities or crypto as collateral, they can access funding to diversify their portfolios with greater exposure to new markets, without having to downsize positions in their home markets.

They could miss out on big return opportunities if they do not.

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[1] https://www.gbm.hsbc.com/en-gb/campaigns/accessing-emerging-markets#:~:text=Over%20the%20last%2020%20years,of%20the%20world’s%20GDP%20growth.

[2] https://www.morganstanley.com/im/publication/insights/articles/article_howmuchtoown_us.pdf

[3] https://www.ftadviser.com/investments/2023/02/06/why-emerging-markets-are-an-attractive-opportunity/

[4] https://www.imf.org/en/Publications/WEO/Issues/2023/04/11/world-economic-outlook-april-2023

[5] https://www.ftadviser.com/investments/2023/02/06/why-emerging-markets-are-an-attractive-opportunity/

[6] https://www.morganstanley.com/im/publication/insights/articles/article_howmuchtoown_us.pdf

[7] https://www.morganstanley.com/im/publication/insights/articles/article_howmuchtoown_us.pdf

[8] https://www.morganstanley.com/im/publication/insights/articles/article_howmuchtoown_us.pdf

[9] https://www.morganstanley.com/im/publication/insights/articles/article_howmuchtoown_us.pdf

[10] https://www.morganstanley.com/im/publication/insights/articles/article_howmuchtoown_us.pdf

[11] https://www.lazardassetmanagement.com/hk/en_us/research-insights/outlooks/emerging-markets