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Emerging markets misconceptions could lead to missed investment opportunities for UK investors

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Investors could be missing out on opportunities to invest in emerging markets because of their misconceptions about the asset class, a recent study by Templeton Emerging Markets Investment Trust (TEMIT) has revealed.

The study, which examined the current attitudes, sentiment and perceptions towards emerging markets of self-directed investors, revealed that their biggest barrier to investing is lack of knowledge, with 58 per cent of respondents saying that they would not consider investing in emerging markets due to the belief that they do not have the right level of knowledge required.
  
The most common misconceptions amongst investors involved assumptions surrounding volatility and risk.
 
Notably, more than three in four (77 per cent) respondents stated that adding emerging market exposure to an investment portfolio would increase risks, and one in four (26 per cent) believed that the risk would be significantly increased. Furthermore, 26 per cent of those not currently investing in emerging markets do not invest because they believe the asset class is “too risky”. This is despite the fact that adding emerging markets exposure can diversify a portfolio and reduce risks.
 
Investors felt that the biggest risks associated with emerging markets are political (29 per cent), volatility (20 per cent) and corruption (18 per cent) risks.
 
Carlos Hardenberg (pictured), lead portfolio manager of TEMIT, says: “Although politics and corruption are commonly associated with how the developed world views emerging markets, it’s important to note that many emerging economies have taken action to enact reforms and improve governance over the past few years. During this time, we’ve also seen a new generation of emerging-market companies develop.
 
“In the past, there were certain periods where corporate balance sheets were under severe stress due to foreign-exchange debt. Today, currency issues are much better managed and corporate balance sheets appear much healthier. In general, emerging market companies have deleveraged over time; they have cleaned up their balance sheets and repaired their business models.”
 
Despite volatility being a key perceived risk, half of respondents (50 per cent) recognised that this can be beneficial for investment portfolios. However, almost a third (29 per cent) held the misconception that volatility is not beneficial for portfolios, unaware that volatility can provide a wide range of opportunities for active managers.
 
Hardenberg adds: “Whilst many investors may dismiss emerging markets as too risky, the rewards they can deliver over time mean they should not be overlooked. In the current low-growth, low-yield environment, emerging markets provide investors with access to innovative, fast growing companies trading at attractive valuations.
 
“Despite the higher growth rates of emerging markets compared to developed-market economies, valuations generally appear much more reasonable. You can invest in many emerging market companies at a price that is a significant discount to what you would have to pay to invest in an equivalent business in the developed world. And, because of their low correlation with each other and with developed market stocks, they offer investors better diversification.”
 
Over half of investors continue to associate emerging markets with traditional industries such as commodities (56 per cent) and manufacturing (50 per cent) – a perception commonly associated with the China-driven commodities bull market of the 2000s. This is despite the fact that information technology and financials currently form the biggest part of the MSCI Emerging Markets index, collectively making up just over half of the index3.
 
Whilst 42 per cent of respondents did associate information technology companies with emerging markets, only 23 per cent associated financials and healthcare (17 per cent) with emerging markets investing.
 
Similarly, investors felt there were fewer opportunities for innovation in emerging markets. Over half (53 per cent) of investors believe the largest number of global patents are registered in the US vs only 9 per cent in emerging markets. It is important to note that over half of global patent applications are now registered in emerging markets. This demonstrates the huge growth in innovation projects in emerging markets, increasing from just 19.6 per cent of global patent applications originating in emerging markets in 2005.
 
Hardenberg says: “Emerging markets are no longer driven by commodities. Gone are the plain-vanilla business models of the past that tended to focus on infrastructure, telecommunications, or commodity-related businesses, and in their place we are seeing a new generation of very innovative companies that are moving into technology and much higher value-added production processes. The technology sector in emerging markets is providing us with many interesting opportunities and we think it’s a very exciting time for investors in this space.”
 

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