Emerging markets looking cheap

Print This Post A A A

Many investors have heard of emerging markets, but what about the ‘BRICs’? This sub-set of emerging market countries covers four powerhouses of global growth – Brazil, Russia, India and China – and both the emerging markets and BRICs have established equity benchmarks behind them: the MSCI Emerging Markets and MSCI BRICs indices, which are tracked by two iShares exchange-trade funds listed on the Australian market (ASX codes IEM and IBK, respectively).

Are the BRICs better or worse investment option compared with the broader emerging market for local Australian investors? And what is the outlook for emerging markets in general?

BRICs vs Emerging Markets

A BRICs focus might be better suited to higher risk-seeking investors because its index performance is more geared to the lesser developed, large emerging-market economies. Indeed, China dominates the BRICs’ index, accounting for 40% of its market capitalisation followed by Brazil with 30%. The other 30% of the index is broadly shared equally between India and Russia.

By contrast, China accounts for around only 15% of the emerging markets index due to the inclusion of the relatively more developed industrial Asian nations of South Korea and Taiwan, which make up about 15% and 10% of the index, respectively. All up, the BRICs only account for around 40% of the broader emerging markets index.

The other difference between the two indices is sector composition. Due to the greater importance of Korea and Taiwan, the emerging market index has relatively more exposure to information technology and relatively less to financials and energy.

Performance

How have each performed? As an investment, emerging markets were the place to be during the roaring energy and commodity price boom in the decade prior to the global financial crisis (GFC). But emerging markets fell harder during the GFC as commodity prices fell and investors adopted an indiscriminate ‘risk off’ attitude.

Led by China, emerging market equities bottomed earlier than the developed world in late 2008 and began a period of solid outperformance for around two years. But relative performance has since trailed that of the developed markets.

The BRICs index has been more volatile on the upside and downside, but it has largely tracked the performance of the larger emerging-market benchmark. China’s market has been especially weak of late, and while other emerging markets have bounced higher over the past year, China’s market remains in the doldrums.

In Australian dollar terms, these indices have also broadly underperformed the S&P/ASX200 index since mid-2009 – not helped by relative strength in the Australia dollar.

All up, earlier hopes that emerging market economies could ‘de-couple’ from the woes in the developed world have not been fully borne out in recent years. It turns out emerging markets still rely on foreign capital inflows to support sentiment in their local market, and this capital can prove fickle in times of crisis. Emerging markets also still rely fairly heavily on exporting to the developed world.

What’s more, emerging markets have had their own problems to deal with. Relatively stronger economic growth – as in China and Brazil – has made them more inflation prone, resulting in less accommodative financial conditions. India has struggled with a slowing in economic reform, while political and energy price risks still afflict Russia.

The outlook

The good news is that the period of emerging market underperformance has left the emerging markets appearing fairly cheap and potentially well positioned to perform as risk returns to global markets. Slowing exports and policy tightening has slowed economic growth and inflation in many emerging markets to a point where policy makers are beginning the process of easing earlier policy tightness.

At a price-to-forward-earnings ratio of 10, the MSCI emerging markets index is trading at the lower edge of its range for the past two decades. Compared with developed markets, the earnings outlook for emerging markets is also stronger while the price-to-earnings (PE) ratio is now trading at a 15% discount. While the PE discount has been greater in periods prior to the global financial crisis, developed markets are now in a notably weaker position than they were back then.

The emerging markets through the IEM and IBK ETFs provide good diversification options as investors begin to feel comfortable re-entering riskier investments.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

Also in the Switzer Super Report

Also from this edition