The evolution of emerging-markets stocks in your portfolio

While headlines typically center on the results for U.S. stock markets, we believe the diversification benefit from exposure in emerging-markets stocks is vital for the long-term success of our clients’ portfolios.

First, let’s define emerging markets and why we think it is important to have them in your portfolio.

Going back to 1988 when the benchmark MSCI EM (Morgan Stanley Capital International Emerging Market) index was created, the emerging markets asset class represented a group of 10 developing countries with the potential of strong economic growth. The tradeoffs for exposure to these countries were higher levels of political, legal, currency and operational risks.

Investors received the benefit of emerging-markets exposure in a significant way from 2002–2007 and periodically since then.

Major index returns (2001-2019)

Major index returns 2001-2009
Source: Dimensional Fund Advisor ReturnWeb

So, what’s changed over the last 20+ years? Emerging markets’ portion of world market capitalization has risen from 4% to 11%.

As you can see from the below chart, the increases have not been smooth or steady. Over the last 20+ years, emerging markets have been impacted, among other events, by the Russian and Asian financial crises and by the decline of Latin American countries’ economies.

Share of MSCI emerging markets in the MSCI AC World Index

MSCI emerging markets in MSCI AC world index
The countries included in the benchmark, along with their weights, have also changed dramatically. Below is a chart comparing the countries within the emerging markets index in 2008 versus 2018.

Country weights within the EM index

Country weighs within the EM index
Source: Callan Associates

Over the last 10 years, commodity exporters such as Brazil and Russia (which had been the leading components of the index) have experienced recessions. Meanwhile China, South Korea and Taiwan increased and now account for over 56% of the MSCI EM Index.

In addition, as noted by Callan, China is now the world’s second-largest economy and also the second-largest equity market compared to the U.S. ($12 trillion versus $26 trillion as of March 31, 2008).

Lastly, industry-sector weights have also changed over the last decade. Based on the following sector-weight comparison from Callan, note the significant increase in weight for information technology, along with steady growth for financials. Historically, large sectors like consumer staples, materials and energy have declined in weight.

Sector weights for the EM index

Sector weights for EM index
Source: Callan Associates

From a country perspective, dominance in Asia in the technology manufacturing space, along with behavioral changes on how consumers shop (social media and the impact of e-commerce) have a lot to do with the current weights of China, South Korea and Taiwan.

What does the future hold for emerging markets?

The most significant factor with emerging markets is not the underlying economic growth but rather the removal of restrictions, which creates opportunity for market access. China comes to mind, as it lifted the barrier for foreign investors to buy stocks in its mainland Shanghai Stock Exchange.

Just recently, MSCI began infusing China-A Shares in the benchmark, which are likely to increase over time. That said, our approach toward this asset class is based on broad diversification across developing countries, along with our bias towards value and smaller size.

In summary, as the official results are tallied for 2019, broad equity benchmarks had positive returns.

S&P 500 Composite                    31.5%

Russell 2000                               25.5%

MSCI EAFE                                21.7%

MSCI Emerging Markets              18.4%

While the last 10 years since the financial crisis have been led by the U.S. market, it wasn’t that long ago (2009) that investors were frustrated over what is now known as “the lost decade,” in which U.S. large cap stocks declined while international stocks posted positive performance. We discussed this very topic in our recent video on international investing. As always, long-term investing requires discipline, patience and time.

If you have any questions about how to put together a well-positioned portfolio or would like to develop one, contact an advisor at Wipfli Financial.

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The evolution of emerging-markets stocks in your portfolio

Wipfli Financial Advisors, LLC (“Wipfli Financial”) is an investment advisor registered with the U.S. Securities and Exchange Commission (SEC); however, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. Wipfli Financial is a proud affiliate of Wipfli LLP, a national accounting and consulting firm. Information pertaining to Wipfli Financial’s management, operations, services, fees and conflicts of interest is set forth in Wipfli Financial’s current Form ADV Part 2A brochure and Form CRS, copies of which are available from Wipfli Financial upon request at no cost or at www.adviserinfo.sec.gov. Wipfli Financial does not provide tax, accounting or legal services. The views expressed by the author are the author’s alone and do not necessarily represent the views of Wipfli Financial or its affiliates. The information contained in any third-party resource cited herein is not owned or controlled by Wipfli Financial, and Wipfli Financial does not guarantee the accuracy or reliability of any information that may be found in such resources. Links to any third-party resource are provided as a courtesy for reference only and are not intended to be, and do not act as, an endorsement by Wipfli Financial of the third party or any of its content or use of its content. The standard information provided in this blog is for general purposes only and should not be construed as, or used as a substitute for, financial, investment or other professional advice. If you have questions regarding your financial situation, you should consult your financial planner, investment advisor, attorney or other professional.
Pat Brault
Pat Brault

CPA, CTFA | Principal, Senior Financial Advisor

Patrick Brault, CPA, CTFA, is a Principal and Senior Financial Advisor for Wipfli Financial Advisors in Minneapolis, MN. Patrick focuses on comprehensive financial planning and investment management for business owners, retirement plans and foundations, as well as advanced planning for seniors and family caregivers.

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The evolution of emerging-markets stocks in your portfolio

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