Nov 02, 2022
Investors focused on growth have traditionally found significant opportunities in emerging economies. After all, these economies are famous for the quick increase of their gross domestic product (GDP), especially compared to the GDP growth of established nations in Europe or the United States. Value investors may have an opportunity to invest abroad if the rate of global economic development continues to decelerate, as it did in 2019 and 2020. This article examines some of the reasons why value investors would be interested in looking at developing markets and how they might become engaged.
Investing in value has gained popularity not just in developed markets but also in developing countries. A vast and rising body of research shows that investing in equities with price-earnings or price-book ratios that are lower than average, or investing in stocks with dividend yields that are higher than usual, results in greater returns over the long term. Successful investors like Warren Buffett have capitalized on this phenomenon to produce returns superior to the market over time.
These characteristics were shown to carry over into developing markets in a report published in Emerging Economies Review in 2002. The article revealed that value equities generated greater returns than non-value stocks in emerging markets. A second analysis by Credit Suisse found that value equities excelled in 18 of the 21 developing economies between 2000 and 2013. The value premium was 4.3% per year in emerging markets, but it was just 3.1% in established nations.
During the Great Recession in 2008, emerging markets saw a significant decline. Things turned for the worst when the Federal Reserve of the United States announced that it would increase interest rates and reduce its quantitative easing (QE) programme. The value of many currencies used in developing markets fell significantly. This makes it more expensive to repay debt denominated in dollars, a method that many governments and enterprises in developing markets employ to borrow money. By the year 2020, this category of debt had reached $4 trillion.
Because many developing markets are not as varied as established economies, these challenges were made much worse by the significant drop in the price of crude oil. Compared to economies of industrialized countries, those of developing countries tend to focus on a smaller number of product categories. When one of those items is oil, economies are hurt more by declines in price.
These factors have caused significant capital to leave developing nations, resulting in a decrease in the value of these markets compared to established markets. On January 7, 2021, for instance, the iShares Core S&P 500 ETF (IVV), which follows the S&P 500 index very closely, traded at a ratio of earnings that was 25.55 times.
Several different vehicles are available for investing in developing markets, such as equities, exchange-traded funds (ETFs), and mutual funds. Building exposure via international ETFs is the most straightforward and cost-efficient method. This is because they include an entire investment portfolio into a single security. Additionally, they often have reduced operating expenditures compared to similar mutual funds. Although a large selection of developing market exchange-traded funds (ETFs) are available, only a few are focused on value investing. Most of these are investments in "smart beta" funds, characterized by their use of alternative indexing algorithms. The following are some of the most popular developing market value ETFs:
There may be an increase in the number of mutual funds that are available to invest in that concentrate on equities from developing markets. However, most are not passive funds; instead, they are actively managed. It's also possible that their expense ratios are much higher than those of ETFs. This indicates that you should consider whether the management's track record and several other variables are worth the extra costs.
Finally, investors have the option of purchasing individual equities either via the trading of American Depositary Receipts (ADR) on U.S. markets or through the trading of international stocks on exchanges located in other countries. Utilizing a stock screener such as FinViz is often the most efficient method for finding these stocks. Keep an eye out for international companies selling at low multiples or offering high dividend yields. The disadvantages of using this strategy include the possibility that it will be more expensive to construct a portfolio and that many of these equities will be less liquid.