For long, there has been a misconception of unwarranted risk in emerging markets (EM) equity investing, but now the risk profile of EM equities has changed, contends Ninety One. “As emerging economies and financial markets have matured, the volatility of their equity markets has shown a steady decline. In fact, in recent years, EM equity volatility has fallen consistently and is now lower than that of developed markets (DM),” explains Sahil Mahtani, Strategist at Ninety One.

The asset manager sees that the growing convergence between EM and DM assets is primarily due to two main factors. Firstly, in terms of governance and frameworks, EM economies have moved closer to DM; Secondly, DM economies have moved slightly closer to EM economies because of their unpredictability and volatility. Daniel Morgan, Multi-Asset Analyst at Ninety One states, “By embracing reform after the crises of the 1990s, the largest emerging markets have now built stronger economies and capital markets.”

Ninety One also emphasises the diversification benefits of emerging markets, saying they have the potential to deliver attractive risk-adjusted returns. The asset manager highlights that emerging markets tend to have lower correlations with other equity markets, usually ranging between 50-60%, compared to the 70-80% correlation of the US and European indices. Morgan argues that these lower correlations enable emerging markets to offer higher risk-adjusted returns in portfolios through the rebalancing mechanism.

The asset manager believes that US equities might lose its charm to EM equities in times to come. Mahtani states, “current valuations will be a significant headwind, particularly for US equity returns. As a result, we expect the return impact of international diversification over the next ten years to look very different to the experience of the last decade.”

Not just that, the analysis by Ninety One shows that EM returns mostly stay competitive against European or Japanese equities. The asset manager emphasises that since 2001, EM outperformed EAFE (Europe, Australasia, and the Far East) two-thirds of the time.

Furthermore, Ninety One believes that ‘decoupling’ from developed markets has made emerging markets stronger in the face of crisis. “EMs would now grow through domestic consumption, decoupling from the developed economies. In other words, even if the latter fell into a recession, the emerging world would stay on its long-term secular path,” Morgan points out.

That said, Ninety One advises investors to develop awareness of the macro drivers of emerging markets and exercise caution while including EM assets as a diversifier in their portfolio.

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