In the early 1980s the Dutch economist Antoine van Agtmael wanted to launch a “Third World Investment Fund” but was told the name wasn’t catchy enough. So he came up with the more upbeat “emerging markets”. In 1985, the first index tracking these stocks was launched. A couple of years later, MSCI created its own benchmark. Fund managers promoted the new asset class with the promise that higher rates of economic growth across the developing world would be accompanied by superior equity returns.
The trouble is that emerging markets are no longer as diverse as they used to be. China, which wasn’t part of van Agtmael’s original index, now accounts for around 30% of the MSCI benchmark. Thus future investment returns from emerging markets now largely hinge upon what happens in the People’s Republic.
To some extent these risks are reflected in current valuations for emerging market equities, which trade at a significant discount to Western stocks. But investment strategist John-Paul Smith, who started running an emerging markets fund in 2001, suggests that that the opportunities on offer today are not as compelling as two decades ago.
What should investors do? Smith believes the concept of emerging markets as a separate asset class is outdated. In his view, it was always a marketing device to draw investors into funds that charged higher fees. He suggests that emerging market investments should be folded into global equity portfolios. At the very least, they should be renamed “less developed markets” to alert investors to their generally weak governance and lack of liquidity.
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