After stumbling in 2011, emerging-markets stocks looked like they were off and running again, posting double-digit gains last year alongside most other global equities.
This year is a different story. While U.S. stocks are delivering sizable gains, shares of developing-market companies are sinking as China’s slowing growth drags down commodity prices.
So are emerging markets out of the running for a place in your portfolio? No, but you need to start looking beyond those that set the pace in the past.
While the so-called BRIC nations — the large, commodity-producing economies of Brazil, Russia, India, and China — are in a bear market, stocks in other emerging economies that are more consumer-oriented have been enjoying healthy gains.
This signals a fundamental shift, says Mark Luschini, chief investment strategist for Janney Montgomery Scott. Instead of commodities and exports to the West, growth in the developing world will come increasingly from local consumer spending.
That isn’t an argument for abandoning China and India — which, in addition to being major commodity producers, also happen to be home to billions of consumers who are at the forefront of this transition.
Nor is it time to slash your allocation to this asset class. Recent underperformance means valuations throughout the region are starting to look “very compelling,” says Arjun Jayaraman, manager of Causeway Emerging Markets.
You do have to broaden your exposure to include other countries where the commodity pullback isn’t such a drag. And you must be realistic. “Investor expectations for the emerging markets are resetting,” Luschini says. While these economies will still grow faster than those in the West, you can’t bank on mid-teen rates.
Here’s a new framework that you can count on:
Think TIMP, not BRIC
From 2001 to 2010, BRIC nations were the darlings of the emerging markets, partly because they were growing at nearly twice the rate of the global economy. Over the next decade, a second tier of countries is likely to drive growth and investor interest.
“Here come the TIMPs,” exclaimed Bob Turner, chairman of Turner Investments, in a recent report, referring to Turkey, Indonesia, Mexico, and the Philippines.
Those countries aren’t nearly as commodity-oriented as the BRICs. Turkey, for instance, enjoys a fairly robust tourism industry. And in Mexico, consumer spending accounts for nearly two-thirds of economic output.
The TIMPs also have lower debt than the developed world. And they recently had their credit upgraded by the rating agencies.
True, China’s economy is still expected to grow faster than those of the TIMPs. Economic growth, though, does not always translate into better stock performance. At the end of the day, markets are driven by the performance of companies, not the countries. And when it comes to corporate earnings growth, the TIMPs are seeing more than 25% faster growth, on average, than the BRICs.
, which keeps 41% fewer assets in BRIC companies than the average emerging-markets portfolio.
New World, which is in the MONEY 70, our recommended list of mutual and exchange-traded funds, charges a front-end load, but its 1.07% annual expense ratio is well below the category average of 1.58%. Over the past three years the fund has returned 5.3% annually, which is nearly three times the returns of its average peer.
Another option: EGShares Beyond BRICs ETF COLUMBIA ETF TR II COLUMBIA BEYOND BRICS ETF
. As its name indicates, this relatively new fund has zero exposure to Brazil, Russia, India, and China. Nor does it invest in South Korea and Taiwan, among the most mature economies in the emerging world. Meanwhile, more than 40% of its assets are in TIMPs.
Think local, not global
Emerging-market growth will increasingly hinge on the burgeoning middle class, which is spending more on cars, clothing, restaurants, and higher-end groceries. The Asian Development Bank, in fact, predicts that consumer spending in Asia will reach $32 trillion by 2030, up from $4.3 trillion in 2008.
What to do. Forget commodity producers and favor consumer companies that cater to households in the developing world.
, another MONEY 70 member, looks for fast-growing industry leaders trading at reasonable prices. Lately this has led to Russian food retailers and Chinese Internet firms. The fund, which has beaten nearly two-thirds of its peers over the past 15 years, keeps 30% more in consumer companies than the average emerging-markets fund.
EGShares Emerging Markets Consumer ETF COLUMBIA ETF TR II COLUMBIA EMERGING MKTS CONS
offers pure exposure to this group, as it invests in 30 large consumer companies that don’t just sell into the emerging markets, they’re also based there.
Think outside the index
Throughout the 2000s, emerging-market funds that simply track the indexes were a great bet. No longer, says Patricia Oey, Morningstar’s international ETF analyst. Funds that mimic the MSCI Emerging Markets index are heavy in BRICs — in fact, Chinese and Brazilian firms alone account for nearly a third of that index.
, for instance, looks for attractively priced businesses with better-than-expected earnings prospects and that are based in healthy economies. Fund manager Jayaraman says he is currently finding good opportunities in Turkey and Southeast Asia.
If you prefer indexing, at least look beyond the traditional MSCI index. iShares MSCI Emerging Markets Minimum Volatility ISHARES INC EDGE MSCI MIN VOLA EMRG MRK
skims the less volatile stocks from the main index. Not only does that give you smoother returns, says Oey, but it reduces the ETF’s stake in BRICs by more than a third compared with the index.