Emerging markets (EMs) played a big part in my formative years. My mother is Brazilian. My father is South African. I was born in Brazil and raised in Rio de Janeiro and São Paulo.

Later, when I began my investment career, South Africa was the first market for which I had responsibility for research coverage. Nowadays, further extending the theme, I invest in a region replete with EMs – Asia.

Ask me to define an EM, though, and you might be disappointed by the vagueness of my response. To be honest, I doubt anyone could supply a truly comprehensive answer – less still a genuinely satisfactory one.

The term “emerging market” was originally coined by the World Bank in the 1980s. It was offered as an alternative to its predecessor, “Third-World Equity Fund”, which was met with an understandably lukewarm reception.

Today the World Bank no longer maintains an official list of EMs. Classification is instead the remit of the International Monetary Fund, a tiny number of academic institutions and, above all, several major index providers.

The World Trade Organisation even lets its members self-identify as “developing” or “developed”. This merely adds to the confusion, as a result of which the question often becomes less a case of what an EM is and more a case of what it is not.

For example, India is tipped to soon become the world’s third-largest economy, while China’s economic might is already second only to the US’s. So why do these countries remain categorised as EMs?

One reason is that sizeable swaths of their populations still earn low incomes and have a poor standard of living. This means fully fledged status as a modern, industrial economy has yet to be achieved.

There are many other considerations that might also be taken into account. They include quality of regulation and/or financial systems, market accessibility, rates of growth and even average life expectancy.

Yet I wonder how many investors think the most significant characteristic of an EM is risk. Historically, investing in these economies has been seen as entailing more uncertainty than investing in developed markets (DMs). That being relatively less developed or industrialised, and sometimes with less stable governments, more volatile currencies and less established markets, always brings heightened investment risk.

Does this view invariably hold true today? I would say not. The data from Asia strongly suggests investors should look beyond such clichés and recognise the potential benefits of diversification in all its forms.

More performance, less volatility

In identifying attractive businesses in Asia, we always search for quality. A company should have an effective operating model, a meaningful competitive edge, good management, a solid balance sheet and a firm grasp of sustainability and governance issues.

It is wrong to suppose such businesses simply do not exist in EMs – or even that they are relatively scarce. They are there. The trick lies in finding them, which is why we believe it is extremely valuable to have a dedicated research team with an on-the-ground presence in the regions in which in invest.

Many of the most promising companies lie towards the smaller end of the market-capitalisation spectrum. Again, though, this does not imply they are inherently riskier.

It instead further underscores the value of having a team capable of unearthing hidden gems. It also highlights the importance of active management in supporting a positive trajectory over time.

So how might a portfolio of such holdings perform? This is where the blurring of the lines between EMs and DMs – at least in investment terms – becomes strikingly apparent.

Since 2000, according to Bloomberg data, Asian small-caps have comfortably outperformed DM large-caps. Specifically, the level of returns from the MSCI Asia ex Japan Small Cap Index during that period has been almost twice as high as that from the MSCI World Index.

Of course, cynics might fall back on the time-honoured trope and say this difference can be ascribed to greater risk. Investors in Asian small-caps have just taken their chances and reaped the rewards, right?

Not necessarily. Take, for instance, data that shows Asian small-caps have experienced notably less volatility than their DM counterparts over the past six years, with the MSCI Asia ex Japan Small Cap Index more settled than its UK, Europe and World peers.

The fact is that every market involves risk – particularly in an era punctuated by geo-economic and geopolitical shocks. Look at the UK’s woes during the past few years. Remember the turmoil that surrounded Europe in the run-up to France’s recent snap election. Imagine what might have happened in the US if Donald Trump had not turned his head a split second before his would-be assassin opened fire.

Ultimately, the key lesson for investors is that diversification across regions, market capitalisations, asset classes and individual stocks might be more prudent today than it has ever been. Diversification is how we spread and therefore aim to reduce risk.

Debates over the deeply nuanced distinctions between EMs and DMs may continue to rage in perpetuity. But there should be precious little dispute – if any – about the likely advantages of locating opportunities right across the investment universe.

 

Important information:

  • The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.
  • Past performance is not a guide to future results.
  • Emerging markets tend to be more volatile than mature markets and the value of your investment could move sharply up or down.

Other important information:

Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG. The company is authorised and regulated by the Financial Conduct Authority in the UK.

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