Opinion

How to make the most from emerging markets

By Lieven Debruyne (China Daily)
Updated: 2010-03-25 11:22

Taking money out of Latin America and investing in GEMs can reduce returns, but significantly reduce risk.

The main negative in adopting a global approach is that the investor has less control over the structural overweight or underweight positions to regions or countries. Although combining a global approach with a regional or country strategy can solve this to a certain extent, it also introduces an additional level of complexity in terms of monitoring net exposure to each region and country.

Regional approach

The main benefit of using a regional approach to emerging markets is to increase the control over the asset allocation decision without losing exposure to the smaller economies in the overall emerging markets benchmark. However, this is likely to require more investment expertise and involve higher costs if the investor brings in a professional.

In addition, although a regional approach helps the investor establish strategic exposure to the various regions, this may not necessarily equate to emphasizing desired thematic tilts. For example, a high level of dispersion within regions suggests that country returns, even within the same region, are not always driven by common factors.

Putting this into perspective, Russia is a clear beneficiary of rising energy prices, whereas Turkey does better when energy prices are falling. In our opinion, the level of control over exposure to particular themes via a regional approach is therefore likely to be overstated.

Country approach

This approach provides the most control over asset allocation, and exposure can be fine-tuned accordingly. However, it can easily lead to a focus on the larger emerging economies with the smaller economies and the frontier markets being overlooked.

Moreover, it will almost certainly require a significant investment in professional advice in order to make informed country allocation decisions within the emerging market universe.

Finally, the cost of this approach is likely to be relatively high compared to a global or regional strategy; both in terms of hiring expertise and managing the strategy.

Rebalancing within a country approach is likely to be less efficient and more costly when moving assets between managers than within a global strategy. In reality, if a country-based approach is to be successful the investor would really need to internalize the entire management of the assets, including stock selection.

In conclusion, we believe the investor should leave the regional/country allocation decision within GEMs to the professionals. Country allocation has the potential to add substantial alpha. In our opinion an asset manager with significant emerging market resources and expertise is much better placed than a typical retail investor to generate returns from this decision.

The author is chief executive officer of Schroders Hong Kong.