10 tips for investing in emerging markets

Men looking at globeBy Tony Featherstone  Australian Financial Review   30 January 2016

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

To gain more precise exposure to Asia, consider investing in active managed funds or index funds that use the MSCI AC Asia (ex-Japan) index as their benchmark. That eliminates the volatile markets in Latin America, Russia and the Middle-East.


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

Exchange-traded funds (ETFs) have their place in portfolios, but index investing in emerging markets means accepting the market return during periods of heavy loss. Paying higher fees for an active fund manager that can limit capital losses makes sense.


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

The average emerging markets fund had 24 per cent exposure to financial companies and 17 per cent to technology at December 31, 2015, Morningstar data shows. Almost 20 per cent was in consumer cyclical and defensive stocks.


9. Currencies

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.

 

Original article here

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