• / Free eNewsletters & Magazine
  • / My Account
Home>Research & Insights>Phillips Curve>The Emerging-Markets Roller Coaster

Related Content

  1. Videos
  2. Articles
  1. Sharpen Your Portfolio Plan for 2014 and Beyond

    Roundtable Report: At the outset of 2014, Morningstar strategists dig into the market's current valuation and expected return, seek out high-quality U.S. and foreign stock opportunities, size up the role of cash today, assess the Fed's impact on the market, and reveal the best ways to fight inflation.

  2. Go Active or Passive in Emerging Markets ?

    For investors who are worried about overexposure to China's volatile market, active funds may be a better option, says Morningstar's Patty Oey.

  3. Seeking Sustainable Growth in Emerging Markets

    Seafarer manager Andrew Foster has outpaced sluggish developing-world markets over the last three years by seeking stable growers.

  4. Lost in Translation: Emerging -Markets Dividend ETFs

    The screening processes for high-quality dividend payers may not be as effective in emerging markets .

The Emerging-Markets Roller Coaster

When the emerging-markets position does pay off, roles may quickly reverse; it will be clients who then love those funds and advisors who must urge pulling back.

Don Phillips, 01/07/2014

Uncorrelated asset classes can do wonders for a portfolio, if one has the discipline to harness them. Unfortunately, that’s a really big if.

In a regularly rebalanced portfolio, an investor is constantly adding to out-of-favor assets while trimming expensive ones. This creates a tax drag in taxable accounts, but it should in time generate superior risk-adjusted returns.

The problem is that buying low and selling high runs against our human tendencies. It’s painful to put more money into your most hated fund, especially when the assets come from a current favorite. Even with the best intentions, the too typical result of a plan to keep exposure to an underperforming asset results in capitulation on the part of the investor and the benefits of having uncorrelated assets in the portfolio are squandered. While seemingly simple to use in theory or from a distance, uncorrelated assets are a struggle to deploy when you’re in the heat of battle.

Many advisors are engaged currently in just such a dilemma with emerging-markets funds. These funds provided a horrifying ride during 2008 and 2009, plunging further and rebounding higher than most any asset class individual investors were likely to have held during the period. Since that time, emerging-markets stocks have been punk performers, trailing staid U.S. blue chips by a mile, causing cynics to describe them as injecting return-free risk to client portfolios.

Advisors, however, are sticking with the asset class, as positive flows into emerging-markets funds at advisor-centric shops like DFA suggest. DFA Emerging Markets Value Fund DFEVX, for example, had flat assets over 2011 despite a 25% loss that year, suggesting very significant inflows. These advisors are likely doing the right thing for the long term. Many top-notch global allocators project emerging-markets stocks as the asset class with the highest potential return over the next five to 10 years.

The question is will their clients still be on board when the good times come? It’s hard to hold an underperforming asset class. Wags start to say that there is no distinction between being early and being wrong. Client morale starts to sag as they see easy gains in their basic equity funds, but losses in what seem to be more-tangential exposures like emerging markets. As Clipper Fund’s Jim Gipson often noted, the utility of an asset class approaches its zenith as its popularity approaches its nadir.

This struggle isn’t new for advisors. I recall an advisor who entered the business in the early 1980s sharing a story with me about how when he joined the firm, its partners, who had lived through the inflationary 1970s, drilled into his head the mantra that they must always put 5% of every client’s assets into gold. He said they did that religiously throughout the 1980s and into the 1990s with little client benefit. Instead, this practice just created an awkward moment at many years’ portfolio review when the firm had to explain to clients why they wanted to maitain or even top up the portfolio’s worst performing fund.

Predictably, the advisor told me, the firm stopped putting gold into client portfolios sometime in the mid-1990s, just before it would have helped clients when the tech bubble burst.

Don Phillips is a managing director of Morningstar, Inc.

©2017 Morningstar Advisor. All right reserved.