Why EM allocation should not be ‘niche’ any more

China's resurgence, visionary infrastructure plans and region's growing middle class are impossible to ignore, says strategist

Why EM allocation should not be ‘niche’ any more

Home bias is not a new concept; we all feel instinctively safer by sticking to what we know. It might be why you haven’t changed shampoo brands in 10 years or why you invariably stand in the cereal section for 10 minutes before, as you do every time, opt for Shreddies.

For investors, this often translates into Canadian energy or financials, with obviously a healthy dose of the S&P 500 and U.S. stocks. It’s worked so far, right?

A big picture view, however, would argue that the world economic order has been shifting towards Asia for a number of years, if not decades. Macan Nia, senior investment strategist, Manulife Investment Management, highlighted a recent analysis of Canadian balanced mutual funds, ETFs and robo-advisor portfolios by The Globe and Mail.

It found that the average weighting towards international stocks was 25 per cent but, Nia added, given the MSCI EAFE Index (the benchmark for international equities) is dominated by Europe and the U.K., the emerging markets share in those portfolio is likely to be even smaller.

He said: “Anecdotally, we hear that retail investors hold at most a 5 per cent direct exposure to the emerging market asset class. While overlooked by Canadian investors, we think exposure to the asset class in an investor’s portfolio is likely to enhance diversification benefits and shouldn’t be viewed as a ‘niche’ investment. Specifically, the Asian emerging markets are a rapidly growing area of the world that we believe will only continue to grow in terms of economic importance.”

One reason why the region is a different proposition now to what it was is demographics. EM’s profile is one of a growing and thriving middle class, which will be vital to drive future consumption growth, potentially contributing nearly 50% globally over the next decade.

Of course, this is expected to be led by China, which is now aiming to lead the world through consumption and technological innovation. Its development is set to be supercharged by a visionary global infrastructure strategy – the Belt and Road Initiative (BRI). The Belt refers to its proposed overland road and rail routes that build on the old Silk Road routes through landlocked central Asia, while the Road refers to maritime trade routes.

He said: “The outcome of the BRI initiative will result in five trade corridors, including railways, highways, pipelines, port facilities, and fibre optic networks. It has an impressive magnitude and reach. It’ll ultimately cover more than 65 countries, nearly 5 billion people (about 60 per cent of the world’s population), and 40 per cent of global GDP. If you strip out the U.S. economy, it would account for nearly 80% of global GDP.

“The BRI initiative will lay the groundwork for China’s influence during the upcoming decades and will help improve the regional economies as their populations gain access to trade, capital, and transportation.

“What drives economic development? In economic terms, it’s human capital, financial capital, productivity, and entrepreneurialism. In everyday speak, it’s the growth of the population, how productive they are, and what resources they have available to them. The emerging markets check all these boxes and despite the strides made over the past couple of decades, they’re still in the early stages of unlocking their potential.”

With nearly three quarters of the world’s population living in Asia and Africa, this is set to continue as nine countries drive nearly half of the population growth over the coming decades. The productivity of these countries has improved materially, and Nia expects the EM  market region to build on this. New technology, and lack of legacy technologies, will aid quick growth and improve the efficiency of their railways, roads and electric grids.

“Look no further than China’s network of high-speed rail, which dwarfs the rest of the world today and likely in the future,” Nia said. “The BRI will expand these technologies into neighbouring economies, unleashing economic potential.”

He added: “Over the long term, the world economic leadership is shifting towards Asia. This provides a favourable framework for emerging market equities. Are your clients positioned appropriately to take advantage of this investment opportunity supported by these favourable trends?”

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