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                                                       Emerging markets
                                                       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
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                                                       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
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                                                     ENGAGED INVESTOR                                             WWW.ENGAGEDINVESTOR.CO.UK                                                          MAY/JUNE 2010   17
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                                                                                                               Issued by BlackRock Investment Management (UK) Limited
     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


      JARGON BUSTER
       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.
       economy.
                                                                                                               Examples include Saudi Arabia and Nigeria.



18    MAY/JUNE 2010                                                 WWW.ENGAGEDINVESTOR.CO.UK                                                           ENGAGED INVESTOR

				
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