Almost nobody owns this asset class, which could produce strong returns.
The chart below displays a study from Morgan Stanley (NYSE:MS) that looked at the actual allocation towards Emerging Market equities (orange) versus the allocations suggested by several widely accepted approaches, such as MSCI market weights or GDP weights (blue).
Investors are strongly under-allocated to emerging markets.
Morgan Stanley looked at various approaches to come up with a reasonable portfolio allocation to emerging markets, based on things such as:
- EM GDP contribution to world GDP
- EM allocation that maximized portfolio risk/return profiles
And the answer was that investors should have 20-30% of their portfolio exposed to emerging markets.
How much do they have instead?
6-8% at best.
The dismal EM performance of the 2010s has contributed to a strong under-allocation of emerging markets as asset managers tend to chase recent trends and behave as a herd.
But with the potential for further US Dollar weakening, a recycling of trade surpluses into domestic economies and fiscal stimulus (e.g. Korea) the tide might as well change over the next 1-2 years.
Emerging markets could be poised for strong returns.
Agree or disagree?
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