Investors balance risk and return in their portfolios by diversifying across asset classes and economies and portfolio managers have long argued that South African investors should stick with American, European and Japanese equities when they invest offshore to avoid excessive emerging-market exposure.
But it means losing out on the accelerated growth of the BRICs — Brazil, Russia, India and China — the world’s dominant emerging-market economies. These countries hold the key to long-term global economic prosperity by dominating international trade, consuming vast quantities of natural resources and regularly topping world GDP growth rankings.
The typical emerging market is rich in resources and boasts a progressive government, young and growing labour forces and the potential to grow from a low base. South Africa is also classified as an emerging economy but, despite the government’s desire to be recognised alongside the BRICs, it falls well short of its peers’ economic prowess.
Local asset managers have been wrestling with the emerging-market conundrum for some time. A properly diversified offshore portfolio is supposed to balance the risk-and-return equation by selecting the correct mix of asset classes and geographies.
The consensus is that South African investors should avoid investing in BRICs because they would simply be transferring funds from one emerging market to another. But does this make sense given the huge disparity in growth between BRIC economies and the southern tip of Africa?
Jeremy Gardiner, director of Investec Asset Management, questions the ‘developed world or bust” investment philosophy. ‘As the axis of power shifts from West to East, developed-world investing is no longer as attractive as it was,” he says. He believes the definitions of ’emerging” and ‘developed” need updating too.
How does one, for example, tag the BRICs as developing and consider Portugal, Italy, Greece and Spain as developed? ‘Going forward, we believe many ’emerging’ countries will morph into the ‘developed’ universe, while frontier markets such as Africa will become the new emerging market.” This clearly complicates asset diversification.
Creating a balanced offshore portfolio is difficult at the best of times. Wilhelm Janse van Vuuren, wealth manager at FNB Private Clients, says the emerging versus developed debate should be replaced with investor objectives.
‘If you can afford volatility and have a long investment-time horizon, then emerging-market concentration is fine.” But if you are in retirement and your offshore assets are integral to your long-term plan, you cannot afford the risk attached to these higher returns.
Portfolio managers must determine, considering the respective market cycles, an appropriate balance between developed and emerging markets . Developed markets had a huge 10-year run beginning two decades ago when US equities went through the roof, but in the past decade
emerging markets outperformed by far.
‘It makes sense for local investors, firstly, to diversify out of South Africa into developed markets and, secondly, into other emerging markets,” says Marcel Bradshaw, head of Glacier International.
You cannot afford to ignore the significant growth and structural differences between South Africa and the BRICs, but you can’t ignore the warning signs either. ‘Every second emerging-market fund launched nowadays is a Chinese fund,” says Bradshaw.
Valuations in China are on the expensive side, and expectations of 8% (or better) annual GDP growth over the next two decades could prove a shade optimistic. ‘I would caution investors not to diversify 100% in emerging markets,” he says.
Gardiner also warns against piling into traditional emerging economies. ‘The problem with dedicated emerging-market funds is that emerging markets have already run hard,” he says.