Why I’m Not Crazy About Emerging Markets

by Mike Holman

Emerging markets are supposed to be the ‘hot’ markets, the place where the adventurous can get more return for more risk which is a tenet of many investment books including Four Pillars of Investing.

I’ve noticed that there are quite a few funds particularly Latin American funds which are extremely volatile but don’t necessarily have “better” long term returns although they have very good recent returns.

I decided to try doing some extremely unscientific research on emerging market mutual funds, using GlobeFund.com – “emerging market funds” category.

When I did the query on the emerging market funds, there were 71 funds available. I sorted by 10 year returns to get all the funds that have been around for at least 10 years which does not include funds which no longer exist but should be counted in the study (survivorship bias).

I got the “since inception” return – this is not all that scientific since the dates are not the same but the idea is that if people bought at the beginning of the fund – that’s the long term return they would have. I took all these funds which have been around 10+ years and put the data on a spreadsheet. This group seems to be mostly Latin American funds.

I removed all the duplicates (ie US$ versions, different classes) and calculated the average return from inception which came out to 6.3%, if we add 2.75% mer that gives us approximately a 9.05% gross return.

Given the extreme ups and downs of this group – the returns don’t seem to match the risk whether you bought the index or a retail mutual fund. By way of comparison the TSX total return for the last 10 years is 10.33% and 15 yrs is 11.88% which is not only higher but with less volatility.  MSCI Europe (Cdn$) was 8.93% for 10 years and 11.78% for 15 yrs.  *S&P 500 Composite Total Return Idx($Cdn) was 5.56% for 10 years and 10.41% for 15 years.

Of course with emerging markets doing so well over the last 4 to 5 years it seems silly to worry about the long term returns but for someone who is thinking about starting an emerging market position now, they should be very cautious.

Are emerging markets worth their volatility? These markets are much more volatile than developed markets so if they don’t outperform over the long term then you are better off sticking with developed markets.

I’m still planning to have a portion of my equity in emerging markets but I plan to err on the side of caution and will go a bit underweight in this sector.

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