Investors around the world are feeling the consequences of the volatility in 2022, but there may be possibilities to be picky within emerging markets.
utilising minimum volatility to gain access to less volatile securities in emerging markets ETFs could be enticing as a method to keep exposure to stocks from emerging markets while possibly carrying less risk as U.S. equities*.
Even though emerging market stocks have recently underperformed, a long-term perspective can support keeping a strategic position.
Validating the product's quality is frequently high on a shopper's priority list when purchasing a car, a washing machine, or a piece of furniture. Likewise with stocks.
The businesses in an equity portfolio must endure the test of time, just as a large-ticket investment is anticipated to perform well for years.
But how can a shareholder determine whether the stocks in a portfolio are actually long-lasting? It's not as easy as looking up customer reviews of a TV. Instead, you should learn how a fund manager selects the securities for your portfolio by assessing the underlying companies' business characteristics. High-quality enterprises that can provide consistent cash flows over time are characterised by dominant industries, competitive advantages, innovation, and management expertise, to name a few characteristics.
Long-Term Return Potential is Supported by High-Quality Features Different metrics can be used to determine a stock's quality. But robust organisations have a trait in that they frequently support predictable, long-term stock return potential. The MSCI World Quality Index outperformed the MSCI World Index during the past ten years, returning 12.4% annually. Additionally, over longer time frames and in both the US and international stock markets, we have noticed that during previous market crises, quality equities typically declined less than the whole market.
Even high-quality equities can occasionally underperform, as no equity portfolio is immune to slumps. Stocks fell in the first half of 2022 as the global economy was on the verge of recession due to growing inflation, increasing interest rates, Russia's attack on Ukraine, and China's COVID-19 shut downs. Quality equities underperformed the market as a whole, falling by 17.5%.
But quality stocks have recovered over time after previous crises. In terms of stocks, we think that short-term return patterns don't always demonstrate the long-term advantages of high-quality stocks. According to our assessment, the early 2022 success of individual stocks was an exception caused by a highly unusual combination of circumstances. We think that after the dust clears, the advantages of a quality-focused strategy will emerge. In this essay, we want to demonstrate for investors how to identify businesses that expose them to excellence and will ultimately benefit them during a trying time.
Keep THE Route AFTER A Bumpy Ride IN EMERGING MARKETS?
Undoubtedly, emerging markets have recently faced difficulties. In the most recent five years, EM markets have lagged U.S. stocks from 2012 to 2022, returning a pitiful 1.1%. Given the recent increase in volatility and the lacklustre actual returns, many investors may be questioning why they should even bother with emerging markets.
Of course, it's hard to predict what will happen in the upcoming ten years. However, maintaining a position in emerging market equities may be prudent from a diversification perspective because US and developing market performance might differ significantly over extended periods of time.
There are various reasons to be hopeful about developing markets in the long run, despite the fact that slowing global growth may hurt them.
Comparative to developed markets, emerging markets appear appealing from a valuation standpoint. In comparison to their counterparts in developing markets, mature financial equities have transacted at a 35% premium over the past ten years. The spread has increased as of March 2022 since established equities are now selling at a 57% premium.
Comparing the current state of EM economies to previous Federal Reserve rate hike cycles, they look to be in better health fundamentally. When the Fed increases interest rates, the currency frequently gains strength. This is typically seen as a barrier for developing markets, making it difficult for them to draw in foreign capital and settle their obligations, which are frequently in dollars.Nevertheless, this cycle may help to reduce that risk: The dollar is at a multi-decade high when compared to other major currencies, and we don't think it will rise much further. Therefore, any drop in the value of the dollar might be advantageous for EMs.
In addition, many central banks in emerging markets began raising interest rates in 2021 before the U.S. Federal Reserve. Therefore, central bankers in emerging markets may be able to loosen monetary policy earlier than in previous cycles.
In addition, a large number of exporters from developing markets have profited from the structural shortage of commodities and stand to earn even more from rising commodity prices. Last but not least, friendshoring, the practise of businesses moving their supply chains to friendlier, less hostile nations, may benefit EM exposures in Southeast Asia and Latin America.
What Sets True Quality Apart?
There are many different sectors and industries where high-quality stocks can be found, ranging from businesses that are more cycle-sensitive to those that have profitable growth drivers. We think investors who put quality first in their regular stock selection processes are stronger able to spot enduring businesses with the capacity to weather turbulent periods and prosper in a recovery.
Investors must exercise caution when analysing a company's fundamental characteristics in uncertain economic times and turbulent market conditions.
Investors can evaluate quality using these three criteria by looking at market conditions, demand variables, and marketing strategies:
Constant growth in profits and earnings- These traits typically indicate that a company has a distinct and resilient business that may succeed despite shifting macroeconomic cycles.
Excellent free cash flow- The lifeblood of the economy, extra cash flow is produced by successful firms. As a result, businesses have more financial freedom to boost shareholder returns.
Favourable balance sheets- Companies with plenty of cash on hand and low debt loads are better positioned to make long-term investments and carry out their strategies independently of the whims of the financial markets.
The three aforementioned qualities interact with one another. Even when there isn't enough cash to maintain the company afloat, companies that consistently create free cash flows are better able to pay their debt-servicing expenses. Additionally, low profit volatility is a favourable sign of a company's resilience to challenging and shifting market conditions.
RISK AWARENESS IN ACCESSING EMERGING MARKETS
Although Latin America has been a surprise, investors may have to be aware of how much risk their portfolios' allocations to EM equity carry. In the past, stocks from emerging markets have typically been 17% more volatile than comparable companies from the United States.
It would be worthwhile to think about investing in reduced risk emerging market stocks through a minimum turbulence ETF, such as the iShares MSCI Emerging Markets Min Vol Factor ETF (EEMV). The index that EEMV aims to track, the MSCI Emerging Markets Minimum Volatility Index, has shown less risk since 2011 than even stocks in the U.S. and other established markets.
Over time, investors who are able to keep their tactical investment strategy in EM equities may benefit. Even if we are not yet prepared to be totally optimistic on emerging markets, the current scenario may offer some chances within EM via low volatility techniques. Through EEMV, investors can acquire exposure to EM companies while taking on risk levels that are even lesser than the volatility seen in the US by investing to the less risky emerging market stocks.
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