4 strategies for investing in emerging markets

by Christopher Dhanraj, Blackrock

Chris explores ways to manage your EM allocation, an out of favor, but still appealing asset class.

Emerging markets were the darling of investors as recently as the winter of 2019, but now find themselves once again as unloved as wearing white after Labor Day. The asset class has suffered under a barrage of tweets, tariffs and uncertainty: The MSCI Emerging Markets Index is down 19% from its January 2018 peak, while the S&P 500 is up 5% over the same period.[1] Exchange traded fund (ETF) flows have followed suit, with nearly $10 billion redeemed from EM equity funds in August alone, putting YTD cumulative flows close to flat.[2]

But just because EM is down doesnā€™t mean itā€™s out. Indeed, signs of resiliency are appearing in the flows, which recently broke their losing street: During the week of September 16, $700 million flowed into EM equity ETFs, primarily in country specific funds tracking China.

Still, it is important to consider maintaining some exposure to EMs, which offer access to growing parts of the globe with rising middle classes and potential diversification and growth. In addition, EM is still quite cheap ā€“ forward price-per-earnings around 12 times versus U.S. equities at 17 times.[3]

Here are four suggestions for investing in emerging markets beyond the traditional regional implementation.

1. Consider minimum volatility strategies.

Investors concerned about volatility may want to consider minimum volatility funds, which potentially can smooth out the ups and downs of EM investing. Consider the example of the recent decline: The MSCI Emerging Market Minimum Volatility Index is down around 10% since January 2018, well outperforming the MSCI EM Indexā€™s 19% drop[4].

2. Tailor your EM portfolio around countries or regions.

The EM landscape is changing: Saudi Arabia, Argentina and China A shares have entered the index, but counterintuitively it is getting more concentrated despite the new entrants. In just five years Chinaā€™s weight in the MSCI Emerging Markets Index has risen from ~20% to 33% currently and is expected to exceed ~40% at full inclusion of China A shares (source: MSCI, as of August 2019).

Investors are taking notice of Chinaā€™s 33%Ā  weighting within EM benchmark.[5] With rising China riskĀ  driven by US/China tensions and lowered earnings expectations, the MSCI China Index has fallen nearly a quarter from its peak, dragging the rest of the EM index down with it. Ā Itā€™s possible that as Chinaā€™s weight grows within the index, weā€™ll see treatment of EM ex-China comparable to that of Developed ex-US or Asia ex-Japan.

One potential solution? Consider carving out China as a standalone allocation through an emerging markets ex-China strategy. More generally, investors can consider adopting a country-focused approach in their international portfolios as I discussed in greater detail in February. Concentrated risk exposures, low correlations across EM, and high return dispersion suggested EMs are well suited for such an approach.

3. Consider a broad-based exposure, but manage political event risk.

Investors may want to consider a differentiated approach for tactical and strategic trading using broad EM exposures, making tactical trades around Federal Reserve meetings or geopolitical events. Where possible, consider currency hedged EM ETFs to play pure equity views, such as in Mexico.

4. Take a look at EM Debt as a potential complement to an EM equity portfolio.

EM debt looks attractive ā€“ with a 30 day SEC yield of 4.4%[6] ā€“ and offers a complementary geographical exposure to the Asia heavy EM equity indexes.Ā  So far in 2019, more than thirty central banks have cut rates, with the Fed and the European Central Bank messaging that further accommodation might be needed.[7] In a global rate cutting environment, investors may be able to benefit by looking to EM debt for a yield alternative.

Whether EMs come back in favor this week or next year, we believe most investors should consider some allocation over the long term to this important asset class. And ETFs can offer the flexibility to implement that allocation through a range of applications.

Chris DhanrajĀ is the Head of the iShares Investment Strategy team and a regular contributor toĀ The Blog.

iShares Core MSCI Emerging Markets ETF (IEMG)

iShares MSCI Emerging Markets ETF (EEM)

iShares Edge MSCI Min Vol Emerging Markets ETF (EEMV)

iShares MSCI Emerging Markets ex China ETF (EMXC)

iShares MSCI China ETF (MCHI)

Carefully consider the Fundsā€™ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Fundsā€™ prospectuses or, if available, the summary prospectuses which may be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing.

Investing involves risk, including possible loss of principal.

Index performance is for illustrative purposes only.Ā  Index performance does not reflect any management fees, transaction costs or expenses. Indexes are un-managed and one cannot invest directly in an index. Past performance does not guarantee future results.

Funds that concentrate investments in specific industries, sectors, markets or asset classes may under-perform or be more volatile than other industries, sectors, markets or asset classes and than the general securities market.

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This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain ā€œforward-lookingā€ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective. The information presented does not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy or investment decision.

This post contains general information only and does not take into account an individualā€™s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

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ICRMH1019U-966120-1/1

[1] Source: Bloomberg, as of 9/25/19. Covers period 1/26/18 to 9/20/19.

[2] Source: Bloomberg, as of 9/25/19.

[3] Source: Thomson Reuters, IBES, as of 9/26/19.

[4] Source: Bloomberg, as of 9/25/19. Covers period 1/26/18 to 9/20/19.

[5] Source: MSCI, as of 9/25/19

[6] Based on the J.P. Morgan EMBI Global Core Index. Source: Bloomberg, as of 9/25/19. Index performance is for illustrative purposes only.Ā  Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

[7] Source: Bloomberg, as of 9/25/19.

This post was first published at the official blog of Blackrock.

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