Emerging markets offer significant alpha opportunities for active managers

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Lonsec encourages investors to include specialist allocation within global equity portfolios

EM equities have delivered strong returns despite heightened volatility.

Emerging markets (EM) equities have delivered strong returns over the long term, despite heightened volatility compared to developed markets, according to a report into the sector by investment research house, Lonsec Research (Lonsec).

In its annual ‘Global Emerging Markets and Regional Equities Sector Review’, Lonsec outlines that 2012 proved an eventful year for emerging market equity investors and expects the sector to grow in prominence in coming years.

The in-depth sector review covers an investment research universe of 27 global EM and Asian equity managed funds.

The main findings of the paper are:

  • EM equities have delivered strong returns over the long term, albeit with heightened volatility relative to developed market equities. Lonsec is of the view that investors comfortable with the risk/reward scenario may consider a tiered allocation to the asset class, commencing with an expansive emerging market fund in the first instance.
  • While the recent period has been a volatile experience for EM investors, the Lonsec EM equity and Asian equity peer group average performance has exceeded the benchmark over short and long timeframes.
  • Home bias in Australian investor portfolios is well known. Lonsec continues to recognise the benefits of global equity exposure and recommends an appropriate allocation to global equities (both developed and EMs) to improve the diversification of portfolios and reduce reliance on the relative fortunes of the Australian equity bourse.
  • Recent events in Brazil, Egypt and Turkey are a timely reminder for investors of the heightened political risk in emerging markets.
  • Frontier markets, the EMs of the future, are not heavily featured within the current financial product suite, although Lonsec observes some fund managers have the ability to tap into this segment.
  • Lonsec’s EM research coverage list continues to expand, reflecting positive regard for the EM economic growth story and local financial product providers looking to tap into growing interest in this equity segment.
  • Despite the volatility of recent years, Lonsec expects EMs to grow in prominence within global equity portfolios in coming years.

According to Steven Sweeney, Lonsec Senior Investment Analyst, the sector review observed that EM investors had experienced a rocky road in the past 12 months.

“Overall, 2012 delivered EM investors a welcome improvement in performance after a fairly brutal year in 2011.

“Performance during the first half of 2012 was dominated by lingering poor sentiment from European sovereign debt concerns and Chinese economic contraction. An easing of these fears in the latter half of the year saw an increase in the demand for EM equities,” Mr Sweeney said.

The Lonsec review found that 2013 triggered further disruption for EM equity investors with debate around the end of the US Federal Reserve’s stimulus program causing a selloff in EMs.

“Forever the hostage to risk appetite, the outlook for EM equities in the second half of the year remains clouded, however opportunities undoubtedly exist for contrarian investors with the benchmark trading at historically cheap levels,” said Mr Sweeney.

“The EM universe captures 21 countries at varying stages of economic and political development and fortunes can quickly swing for individual nations – this year’s market darling is quite often next year’s cellar dweller.

“EM Equities should not be treated as a play area for the casual day trading investor – there are numerous risks requiring specialist skills and tailored investment approaches. Fortunately, the Lonsec universe includes a number of specialist EM managers

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