The emerging markets were last year’s laggards, getting swept up in the same risk aversion as developed economies. But there are upsides to that interconnectedness.
Canadian investors have benefited handsomely from holding the resource companies that supply the emerging markets with the raw materials needed for urbanization and industrialization.
But using the resource sector as a proxy for emerging markets gives the investor exposure to only one side of the growth story, says Craig Swanger, executive director and head of Macquarie Global Investments.
“Both the infrastructure and industrial production sides are demanding massive quantities of hard commodities and that’s the boom that we’ve been enjoying in both Canada and Australia for the last 10 years or so,” he says.
“If you were investing purely in Canadian resource stocks, yes you’re getting access to the infrastructure boom in China, but you aren’t necessarily getting access to the middle class wealth creation trend.”
The creation of China’s massive industrial capacity has created a huge number of new jobs in its cities. Incomes have risen dramatically and the world as a whole is now experiencing the biggest boom in its middle class. By definition, the middle class has disposable income, and its ranks in China alone are growing by 300 million people—nearly the entire U.S. population.
“Now they’re in a situation where they can afford to buy a car, or a refrigerator,” he says. “You do not need to invest in emerging market stock exchanges in order to generate wealth from the emerging markets economic boom. The two are totally different. We are now a global economy.”
He says a pure-play emerging markets investment—one made on the exchange of that country—is probably inappropriate for anyone but the largest institutional investors. The developed markets all offer companies that benefit from the emerging market boom.
Canadian, U.S. and international equities are all correlated to each other, making sector selection far more important than geography. Because the world is far from an equity bull market at present, Swanger says, the key is to pick the sectors that will outperform relative to the index.
“If you follow the crowd and invest in the index, the coming decade could be relatively disappointing,” he says.
Many investors are drawn to broad-based emerging markets index funds, but they may not be getting the diversification they want. Active managers are able to focus on the sectors that will benefit the most from the massive transformation.
“Emerging markets is a very broad market. If you’re going with an index, you’re getting every sector and you’re getting every country,” says Swanger. “It’s a very big universe and a lot of those countries have high potential, but at the moment are not doing so well—India is an example.”