Many funds are joining in the fun indirectly.
There's good news for those interested in capitalizing on growth in emerging markets--you probably already have more exposure than you think. When you look at where companies sell their products, not simply where they are domiciled or on what stock exchange their shares trade, an interesting picture emerges.
If you focus purely on conventional labels, most diversified foreign-stock funds or world-stock funds don't have significant emerging-markets stakes. The typical foreign large-blend fund has less than 8% of its assets in emerging markets, and the average world-stock offering has less than 7%. (Not surprisingly, the average foreign large-growth fund has far more--at nearly 15% of assets.)
Economic versus Equity Market Exposure
Because of these relatively small average weightings, the traditional view has been that to get significant emerging-markets exposure, investors would need to buy a diversified emerging-markets fund, or even a regional or single-country fund. This tied in with the notion that regardless of where a company does business, its stock price will usually move with its home market. This has tended to be true especially in the short run, where emerging markets have often moved together during corrections.
Over the long haul, however, a company's value will depend more upon its cash flows and less on where it is headquartered. With this in mind, many equity managers have been looking for companies that will benefit from economic growth in emerging markets, regardless of where those companies are based.
This is the idea, for example, behind American Funds New World's
This currently includes consumer-staples company Nestle. It's headquartered in Switzerland but derives about a third of its sales from emerging markets. About 40% of Spanish telecom Telefonica's
Such Europe stocks, though, have been a slight drag on New World's performance, as emerging-markets equities have beaten developed-markets equities during the past decade. The fund has held its own, gaining nearly 9% annually. But the average diversified emerging-markets fund has gained nearly 10% per year over the past decade. Meanwhile, the typical foreign large-blend fund has struggled to keep pace with an interest-bearing checking account (that is, 0.22% annualized).
How Best to Play It
But while emerging markets' gross domestic product is almost certain to continue growing more quickly than developed markets' GDP, that doesn't guarantee that firms in developing countries are the only--or even the best--way to play that growth. Standard Chartered, for instance, is based in the United Kingdom, and its shares trade there; but it's a leading banker in Asia, the Middle East, and Africa, where most of its customers reside. On the other hand, Korea's Samsung Electronics gets about half of its revenues from developed markets.
Valuation is a key consideration as well. Diversified foreign-stock managers looking for the best way to access emerging markets sometimes find that developed-markets companies provide the cheaper path. Telefonica, which also owns a stake in China Unicom, has a price/sales ratio of 1.3. The stock has been hurt by its connection to its home market, Spain. But Spain now accounts for less than half the company's revenues, and Telefonica is now the dominant player in Latin America (excluding Mexico). Meanwhile, Mexico-based America Movil's
Many mutual fund managers are looking to take a similar backdoor approach to emerging markets. For instance, Harbor International
Commodity plays are another avenue for those looking to tap into the developing world's growth. Many managers believe oil and other commodities will climb higher as emerging-markets demand increases for both energy and basic materials. Causeway International Value
While their home markets are hurting, such European companies may potentially benefit from the declining euro as well. With China recently announcing that it will allow the yuan to gradually appreciate, both European and U.S. companies could have an easier time selling their products there and throughout Asia, as other regional currencies may move up with the yuan.
This points out how U.S. companies are just as inclined to benefit from emerging-markets growth, too. It's well known that S&P 500 Index components such as Coca-Cola
Even those who do not own emerging-markets funds can still benefit from their economic growth. A secondary benefit of indirect exposure may be sidestepping some of the volatility that can sometimes accompany them. What's also clear is that the line continues to blur between emerging and developed markets. So, in order to get a handle on a fund's true geographic profile, one needs to go beyond just looking at the domicile of a portfolio's holdings.
Kevin McDevitt is a senior mutual fund analyst with Morningstar.
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