At the same time, media pundits are pointing to currency devaluations, declining foreign reserves, moderating growth in China, and the impact of the U.S. reducing its quantitative easing to further fan the flames of emerging markets fear that appear to be growing every day.
Many Wall Street firms, meanwhile, are maintaining that emerging markets are likely to be volatile in the coming months. For advisors, emerging markets volatility, like volatility in all asset classes, can be trying as many clients may seek to sell their foreign holdings in favor of more defensive investments.
Yet, just like any period of market volatility, investors who take such actions risk missing out on future market rallies that may potentially restore the losses of late and then generate additional gains. By selling their emerging markets positions, clients may also have to contend with taxes on any capital gains that they may realize.
Clients also need to consider transaction costs and how they will invest the money that they pull out of emerging markets. With that in mind, the stormy times for emerging market can be a powerful opportunity for advisors to strengthen their relationships with clients by providing a voice of reason and explaining why bailing out of emerging markets may be a costly mistake.
In other words, the challenge is to ensure that clients make informed decisions and hopefully choose to stay the course. One starting point may be a discussion about risk tolerance.
For example, advisors should point out that they have included an allocation to emerging markets in portfolios that are structured as long-term investment programs. With long time horizons, investors are more likely to make up short-term loses when emerging markets’ negative performance reverses.
Many of the arguments about market timing, furthermore, are relevant to emerging markets. For example, investors who panic-sell during market declines often miss out on the strong performance that follows stormy periods.
In many instances, market gains may be clustered within a limited number of days each year, so missing out on those days can greatly limit investment returns. Just as U.S. equities tend to perform best after market declines, emerging market performance is often best following periods of volatility.
According to the Callan Periodic Table of Investments, emerging markets were the worst performing asset class in 1998, 2000, 2008, and 2011. In each of those instances, except for 2000, they outperformed all other asset classes in the years immediately after having trailed other asset classes.
The performance in bad years, of course, was noteworthy, ranging from declines of 18.7% to 53.18%. Yet, performance following the bad years was considerable, with returns as high as 79%.
Advisors should also point out that emerging markets are just one component of a diversified portfolio. So, even if emerging market stocks decline considerably, the overall performance of a client’s portfolio may still be positive as other asset classes may generate positive returns.
It’s also important to note that the fundamentals of emerging markets remain attractive. In a recent linkedin posting, Mark Mobius of Franklin Templeton presents three compelling arguments for emerging markets. Broadly speaking, emerging markets are growing at roughly three times the rate of developed markets and emerging market countries have debt to GDP ratios that are generally lower than developed markets. The countries also tend to have greater foreign reserves than those of developed markets.