In recent months, Innovest solicited comments about China from several emerging markets managers who have passed our rigorous due diligence process. Some EM managers looking for long-term value were adding exposure to Chinese stocks, including in those companies that may benefit from regulatory changes. Other managers in search of earnings momentum were trimming their Chinese exposures. Perhaps most notably, none of the managers who we contacted were abandoning all exposure to China’s stock market.
Recommendations
Bad news about political and regulatory interference in a country’s economy, while unwelcome, is usually reflected quickly in stock prices. Bear markets create opportunities. It is important to note that while China’s stock market fell 33% during the first nine months of 2021, the more broadly diversified MSCI EM Stock Index had a pullback of less than 15%. Country diversification within the emerging markets will likely continue to benefit investors going forward.
As EM economies evolve, they ordinarily shift from lower-cost, labor-intensive industries such as agriculture and manufacturing to higher paying, service-oriented sectors. Technology stocks, which represented about 2% of the EM index in 1995, are now the largest sector in the index at 21%. The increase in higher paying jobs has fueled the growth of the middle class and economic growth through higher consumption. According to Lazard Asset Management, the EM middle class is expected to represent 58% of the world’s middle-class population by 2030.
As of early 2021, Innovest’s Capital Markets Expectations for the next five to 10 years anticipated that emerging markets should have the highest expected volatility and the highest expected long-term returns when compared to U.S. and international developed markets stocks. We believe that the best approach to global equity diversification includes an appropriately sized allocation to EM equities, as well as diversification within EM by countries, sectors and stocks. Considering the risks and long-term return opportunities in the emerging markets, including China, we remain comfortable with our recommended EM equity allocations.
Innovest believes that the soundest approach to investing in the emerging markets is not to micromanage country exposures, but to entrust the country, sector and individual stock decisions to those professionals hired to evaluate those opportunities on an ongoing basis. A patient, long-term outlook is the approach that is most likely to be rewarded for equity investors.
Scott Middleton, CFA, CIMA, is a principal at Innovest Portfolio Solutions, and Peter Girard is an analyst at Innovest Portfolio Solutions.