Market Commentary

Why we invest internationally, and what is an emerging market?

October 2017

"Broad, wholesome, charitable views of men and things cannot be acquired by vegetating in one little corner of the earth all of one’s lifetime." – Mark Twain

Investing, like many aspects of our lives in 2017, has become global. We buy cars designed in Japan, manufactured in Mexico, and sold in the US. We buy countless goods from Amazon, based in Seattle, that say 'Made in China'. To top it all off, air travel and internet connection has shrunk the world in ways that Ferdinand Magellan could never have imagined.

None of the above statements are surprising. And, yet, the idea of investing in international stocks or 'emerging markets' still seems foreign to many people. So what exactly is this investment that has driven a good portion of the recent growth in our client portfolios?

Why do I need to invest abroad? Aren't there enough good companies in the US?
Our work with clients involves careful attention to investment diversification, not only between stocks and bonds, but also between countries and regions that behave differently and offer unique risks and growth opportunities. While cash acts as a ballast in difficult markets, higher risk/reward areas like emerging market stocks and bonds can be growth engines of the portfolio due to higher overall economic growth rates in those regions.

Due to lower valuations and therefore perceived opportunity, we began emphasizing emerging markets in our client portfolios a little more than a year ago, and increased them to an overweight in December 2016. Year to date they have been the largest driver of growth in most client portfolios with the index up 27.2% through the end of Q3, and it’s worth noting that both of our core EM funds have outpaced the index this year.

What does 'emerging market' mean?
The term 'emerging markets' was originally coined at the World Bank in 1981.¹ It was, quite simply, a marketing ploy – really, a less offensive way to attract investment to countries then described as 'third world'. MSCI’s Emerging Markets Index, launched in 1988, initially consisted of 10 countries representing less than 1% of world stock market capitalization. Times have changed though, and today it includes 24 countries representing 10% of world stock market capitalization.²

Some of the 24 countries are further along in their political, economic and financial development; others are still working to build stable systems. Their shared characteristic is a higher rate of economic growth, and often a shift from agrarian or commodity-based economies to more consumer-driven and industrial economies.

What kinds of countries or companies am I invested in?
There is an old investing adage that Wall Street is "not a stock market, but rather is a market of stocks". This tries to remind us that each company has its own balance of opportunities and risks; that diversity is the basis of most stock market headlines. The same is true in the list of emerging market countries, which is geographically diverse, have different languages, political systems, cultures, and histories. They range from the giant economies and landmasses of China and India to the geographically smaller but growing economies of Chile and Peru.

Global companies can make this distinction blurry at best. Samsung Electronics, which is owned inside our core EM fund, is a South Korean company based on the location of its headquarters and South Korea is categorized as an emerging market economy. Just over 62% of the company's revenue comes from developed economies, however; only 31% of its revenue comes from emerging markets. Apple, of Cupertino, California, has nearly an identical revenue mix: 62% comes from developed economies, and 32% from emerging economies.³

The phrase ‘emerging market’ evokes images of underdeveloped destinations that might be the focus of one of Anthony Bourdain’s culinary adventures. However, the types of companies we own in these markets range from a healthcare firm in the United Arab Emirates that focuses on IVF and the growing fertility market internationally, to the Chinese firm Tencent that focuses on mobile gaming and advertising to a growing consumer base in China and has grown at an impressive rate this year. These are modern companies for the modern investor, and we feel provide good opportunity with reasonable risk.

For our clients that have elected some degree of progressive screening in their investment portfolio, we use a manager that takes into account environmental and governance factors when selecting companies, since many of these developing economies don’t have the same labor laws or environmental regulations that we see here in the United States.

In conclusion
We’ll conclude as we started, with a nod to diversification. Emerging markets stocks currently represent 6-7% of our typical client portfolio because they allow our clients to participate in faster growth outside the United States, and simultaneously help reduce overall portfolio volatility as an asset class that behaves differently at different times.

As always, we are grateful for the trust our clients put in us, and are happy to have a more in-depth conversation with any one of you or anyone in your communities.

This is a general assessment of client portfolios and does not reflect the specific circumstance of every client.

1. http://knowledge.wharton.upenn.edu/article/when-are-emerging-markets-no-longer-emerging/
2. https://www.msci.com/emerging-markets
3. Source FactSet. Revenue figures based on 2016 data.