In this instalment, we explore the diversification benefits associated with an appropriate
exposure to the rapidly expanding emerging market segment
Ensuring their scheme’s return portfolio is Figure 1: Emerging economies as a percentage of total driving the emergence of a huge domestic
appropriately diversified is an important world (2008-2009) consumer base in many emerging markets,
consideration for trustees when setting and which is set to form the foundation of private
reviewing their investment strategy as it helps consumption growth in the developing world.
achieving a better balance of risk and return As a result, many emerging economies are
within their portfolio. In practice – as we expected to become less reliant on exports as
explored in more detail in the dedicated domestic demand becomes an increasingly
reference card published in June 2009 – significant engine of growth.
diversification depends upon investing in an
appropriate number of different sources of Figure 2: Working age population – emerging vs.
return that behave differently throughout the developed
economic cycle. To achieve that goal trustees
now have access to a wide range of return
assets beyond the traditional developed equity
market and fixed income markets. These
include property, commodities, private equity,
hedge funds (which we cover in this edition’s many portfolios. Emerging markets only make
reference card) but also emerging market up approximately 12 per cent of the global
assets. While not strictly speaking an equity market capitalisation on a float-
‘alternative’ asset class, emerging markets adjusted basis (i.e. freely traded shares)1.
offer the prospect of meaningful portfolio The potential for higher rates of long-term
diversification as they provide investors with economic growth from emerging markets
access to different demographic and economic relative to developed markets provides the key
growth dynamics as well as the potential for investment rationale for allocating equity and POSITIVE ECONOMIC FACTORS
higher long-term returns. While many pension fixed income investments to these countries. The financial crisis of the past few years has
funds will have some indirect exposure This outlook is supported by positive long- highlighted the relatively strong position that
through their developed market portfolios, term demographic trends, with emerging emerging markets are in today. A key threat to
these do not capture fully the emerging markets also well-positioned relative to many global growth that has weighed on confidence
market opportunity set. Overall, emerging developed markets on a number of economic is the high debt burden carried by public and
markets remain underrepresented in many measures, including debt levels and saving private sectors. Generally, emerging markets
portfolios. We believe that trustees should ratios. have stronger balance sheets than the
question this imbalance and consider if over developed world. These lower levels of
the long term they have an appropriate DEMOGRAPHICS DRIVE LONG-TERM PROSPECTS consumer and government borrowing allowed
exposure to emerging markets. A mainstay of emerging market growth them to emerge from the credit crisis of the
potential is positive demographic trends. past few years in a much stronger position
Cut out and add to your Trustee MasterClass binder
AN IMPORTANT INVESTMENT SEGMENT Strong population growth in these markets than the developed world.
The term ‘emerging market’ was coined in the has provided a demographic ‘sweet-spot’ with Emerging markets are now also in a strong
early 1980s. At that time, the emerging a rapidly increasing number of people in these position compared to their developed peers.
markets investment universe included eight economies that are of working age. Figure 2 While the banking sector in the US and
countries: Argentina, Brazil, Chile, Jordan, shows this segment of the population, taken Europe has been severely affected by the sub-
Malaysia, Mexico, Philippines and Thailand. as being between the ages of 15 and 64 prime debt market collapse, the banking
Today, 22 emerging markets are included in years, in developed and emerging markets. system in emerging markets had very little or
the MSCI Emerging Market Index. Figure 1 While this group is increasing rapidly in the no exposure to these issues. As a result, these
illustrates the scale and importance of emerging world, the reverse is occurring in the banks are generally well capitalised and not
emerging markets on the global stage today. developed economies, where the working suffering from the lending constraints that
Despite their size, growth prospects and population is actually expected to peak this remain evident in the developed world.
increasing significance on many measures, year. In terms of lending, emerging markets also
these markets are still under-represented in This expanding working population is appear to be at the beginning of a supportive
ENGAGED INVESTOR WWW.ENGAGEDINVESTOR.CO.UK MAY/JUNE 2010 17
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credit cycle. Household debt levels are low Investment managers must demonstrate (authorised and regulated by the Financial Services Authority).
and the penetration of products such as bank extensive research and investment experience Registered office: 33 King William Street, London, EC4R 9AS.
accounts is at low levels in many markets. in these markets to offer trustees the comfort Registered in England No. 2020394. Tel: 020 7743 3000. For
Household savings rates are also high – in they should demand. your protection, telephone calls are usually recorded. BlackRock
China, for example, households saved in is a trading name of BlackRock Investment Management (UK)
Limited. All financial investments involve an element of risk.
excess of 30 per cent of their disposable SIGNIFICANT PROGRESS
Therefore, the value of your investment and the income from it
income during 2008 versus 5 per cent in the Of course, even if strong economic growth will vary and your initial investment amount cannot be
US2. occurs and this is associated with above guaranteed. Past performance is not a guide to future
The growth of credit, for example the use of average company profit growth, this provides performance and should not be the sole factor of consideration
credit cards, from relatively low levels should no assurance of superior returns on emerging when selecting a product. The information has been provided for
provide a boost for emerging economies. The market assets. It must also be noted that information purposes only and may be subject to change without
range of goods available, the increasing emerging market equities have made notification. This material is for distribution to Professional
affordability of consumer products and the significant gains over the past year, but we Clients and should not be relied upon by any other persons.
number of people who are now able to believe that valuations have yet to reach
purchase them provide further impetus for the levels at which they would represent a WHAT ARE YOUR EDUCATION NEEDS?
growth of domestic consumer demand. These significant headwind. Support is also likely to
factors support the increasing influence of come from further gains in corporate earnings, Want to know more about matching your
domestic demand driving economic expansion with the risks focused around higher interest investments with your liabilities? Sign up for the
in emerging economies. rates in some countries. Overall, we believe BlackRock Trustee Masterclass tutorial and talk to
that the moderate valuation premium over
RISK AND DIVERSIFICATION developed market equities is likely to be the experts in person:
Risk levels in emerging equity markets are maintained.
typically higher than in developed markets. Trustees should, however, remain mindful How to manage your investment strategy in line
For example, the volatility of emerging that the performance of their investments will with your liabilities
markets has been consistently higher over the be influenced significantly by their investment London, 10 June
ten years to end-December 2009 versus time horizon and entry-level valuations.
developed market equities3. But despite this, Nevertheless, we believe that as long-term Birmingham, 24 June
if our house views on the prospects for investors, pension funds are well placed to
emerging markets returns over the next few build appropriately diversified allocations that Visit www.trusteemasterclass.com to sign up for
years are correct, the trade-off between offer the prospect of participating in the this event. By signing up on BlackRock’s website,
expected reward and risk should improve strong growth potential offered by emerging you can also view training videos and
when emerging markets are included in a markets. ■
portfolio. presentations from BlackRock’s recent trustee
Along with their greater volatility, emerging 1 Source: MSCI, December 2009 training sessions covering:
markets are perceived as bringing greater 2 Source: Credit Lyonnais Securities Asia ■ DC trends
political and operational risks. As a result, 3 MSCI Barra and BlackRock ■ Developments in Regulation, Administration
effective risk management is crucial. and Investment
EMERGING MARKET: The term ‘emerging market’ EMERGING MARKET INDICES: The MSCI Emerging market debt. These bonds are issued in local
was coined in the early 1980s. There is still no Market Index is the most widely used emerging currency and provide a range of additional
universally accepted definition of what classifies market benchmark. Indices from FTSE are also opportunities for credit investors.
a country as an emerging market and the major commonly used.
index providers (such as MSCI and FTSE) EMERGING MARKET SOVEREIGN DEBT: Bonds
maintain their own lists. However, these markets EMERGING MARKET CORPORATE DEBT issued by emerging market governments, also
are typically considered to be fast growing (TRADITIONAL): Bonds issued by companies in usually denominated in US dollars.
countries with low to medium per-capita income emerging market and denominated in US dollars.
FRONTIER MARKET: These markets are classified
levels that have undertaken economic
EMERGING MARKET CORPORATE DEBT (LOCAL as a type of emerging market, but characterised
development and reform programmes, and
CURRENCY): Recently, there has been an as being less developed in terms of
‘emerged’ as significant players in the global
important evolution in ‘local currency’ emerging infrastructure, capitalisation and market liquidity.
Examples include Saudi Arabia and Nigeria.
18 MAY/JUNE 2010 WWW.ENGAGEDINVESTOR.CO.UK ENGAGED INVESTOR