Investors looking to spread their risk can innocently end up with a less diversified portfolio than they intended by putting money into emerging markets.
Some investors looking for growth will consider emerging market funds without realising that the investment base of the fund is often quite narrow – mainly comprising mining and commodity stocks.
In the race to diversify, these investors move cash out of developed market stocks that have a broader balance and less risk, argues Simon Edelston, manager of the Artemis Global Select Fund.
“The problem these investors face is that raising capital on a stock exchange is a relatively new concept to companies in emerging markets,” he said.
“More and more, when investors drill down, they will find that fewer companies than expected are listed relative to the size of the country’s economy. Then, many are mining or commodity based businesses.”
Another alternative is a high-yielding fund that tracks British equities – but these funds are also overflowing with mining and commodity shares, so the investor is not winning any diversification.
Edelston also has some other tips for emerging and frontier market investors.
First, he explains he makes no differentiation between emerging and frontier economies.
The issue is not which type of market a country may be in, but how the market performs.
“Take China,” he said. “Everyone felt China was on the way out a couple of years back, but the nation is still showing 7.5% a year GDP growth. This may not be spectacular compared to recent years, but its steady and reliable.”
Edelston considers Chinese equities have merits for investors, and that talking the economy down has created value in many companies.
Fund manager tips
He tips the Communications Bank of China to return at least 5.5% I 2013.
Too much reliance is given to GDP for emerging market countries, is another point Edelston feels is misplaced.
“Just because the GDP is expanding at a certain percentage rate does not mean companies on that country’s stock exchange are good value for many,” he said. “There’s no magic formula that converts one to the other.”
His tip for investors – steer clear of putting cash directly into emerging economies altogether.
“Instead, look for companies in other markets that have a large exposure to emerging economies,” he said. “Unilever for one does at least 50% of their business in these markets.”