Emerging economies don’t always produce the best equity opportunities

China and India are on fire, but past returns in the West are just as high.

 

Brad Pitt didn’t win the Oscar for his turn as baseball general manager Billy Beane, but the movie adaptation of Moneyball did result in renewed attention to Michael Lewis’s excellent 2003 book. In it, he traces how Beane’s Oakland A’s rejected decades of received wisdom about what made baseball players successful— how their bodies looked, how they carried themselves on the field—and instead won by analyzing statistics and focusing on quantifiable results.

I think Beane’s approach can work for investors, too. When you consider which markets to invest in, emerging market s such as China and India seem to have the swagger of a cleancut California kid with a strong jawline and a 95-mile-an-hour fastball. And yet if Beane were an investor, I think he’d be more attracted to opportunities in the developed markets of North America and Europe instead. It’s true that emerging-market GDP growth is projected at 5.6% this year—well ahead of developed- market projections. But long-term, the data suggest that higher GDP growth doesn’t necessarily bring higher stock market returns. As Yale’s endowment fund manager David Swensen explains in Pioneering Portfolio Management, “Market observers frequently confuse strong economic growth with strong equity market prospects.”

Emerging markets have definitely benefited as villagers have migrated to cities, working better jobs and spending their higher wages. But shadier legal frameworks and poor corporate governance in such markets can erode profits for shareholders. As Swensen writes, “A particularly prevalent problem in many Asian countries involves family-controlled companies satisfying family desires at the expense of external minority shareholder wishes.”

And while their economic growth has run circles around America’s, data stretching back to 1985 show that U.S. stock markets have comfortably beaten aggregate emerging market returns over the past quarter century.

Numbers from the World Bank’s International Finance Corp., for instance, reveal that $100,000 invested in an emerging- market index 26 years ago would have been worth $1.08 million by 2006. The same $100,000 invested in U.S. markets would now be worth more than $1.3 million. Since 2006, that gap has narrowed, but it hasn’t closed.

Here at home, you’ll find that over the past six years the total return for the Canadian stock market index was a substantial 13%—compared to a total return on the MSCI Emerging Markets index of, well, roughly 13%. So why take on the higher risk? To be fair, we can’t know the future; it’s possible that returns from emerging-market stocks will eventually overtake their developed-market counterparts. But I think Billy Beane would place his bets based on the data, not the hype, and resist overweighting foreign markets. You might be wise to do the same.

Andrew Hallam is the author of Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School

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