Investing in emerging markets can be tricky. Here are 10 tips to give you the best chance of success.
1. Asset allocation
Most portfolios should have only a fraction of assets invested in emerging markets. The average allocation by international share funds managed from Australia is about 5 per cent, according to Morningstar. Conservative investors who cannot withstand short-term volatility should avoid these assets.
2. Investment horizon
Take a seven-to-10-year view. Annual returns in emerging markets can have large swings, so aim to smooth volatility with a long-term approach. Position portfolios to take advantage of favourable economic fundamentals, such as middle-class consumption growth in Asia that will take a decade or more to play out.
3. Know what you are getting
Investors seeking large exposure to Latin America, Brazil, parts of Africa or other frontier markets will not get it through emerging markets funds. About 65 per cent of the Emerging Markets index is based on equities in China, South Korea, Taiwan and India. An investment in emerging markets is increasingly a bet on Asia.
4. Consider narrowing exposure
5. Take a fund approach
Diversification is critical in emerging markets. Use a fund that provide exposure to a basket of companies across several countries.
6. Choose active over index funds
7. Consider other approaches
Another strategy is owning funds that invest in US or European multinational companies that benefit from growth in China, India or other developing economies. Although not providing pure exposure to emerging markets, company quality is higher and risk is lower.
8. Know what the fund owns
Currency movements can have a big impact when investing in funds that are not hedged against changes in the Australian dollar relative to other currencies. As a commodity-based currency, our dollar now tends to be more correlated with Asian currencies. Currencies are hard to forecast, but understand how the fund would be affected by currency falls in emerging markets.
10. Assess the manager
Usual rules apply: what is the manager’s reputation, past performance and investment style? What are the fees? Does the manager have a long record of investing in emerging markets and people on the ground in those regions? Emerging markets require specialist investment skills acquired and developed over time.
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