WHILE markets continue their volatile run, it’s useful to take a step back and look at some general themes and patterns. This week we look at why developed market equities take preference over emerging market (EM) equities.
We often talk about the relative strength of emerging economies versus the faltering growth rates in the developed world. Brazil, Russia, India and China (known collectively as BRIC) are expected to grow by 7.4% this year and 7.1% in 2012. This compares to the paltry 1.4% and 1.7% expected from developed economies.
However, by looking at the earnings growth of companies within emerging markets compared to those in developed countries we get a different perspective.
The reality is that developed market companies now benefit from a broad geographic footprint, making the overall growth or GDP of the country where the business is headquartered less relevant.
US companies now generate more than 40% of sales from outside their home market. Most of these sales are derived from other developed economies such as Western Europe, Japan and Australia.
However, we’re also seeing an ever larger piece of the pie coming from Asia and Latin America. A similar picture is evident among European companies.
Therefore large-cap multinational companies can mitigate some of the slow growth environment in their mature markets by tapping into the faster-growing emerging economies.
From a valuation perspective, developed market equities look more appealing to us than EM equities. While the past 10 years has seen EM equities outperform developed markets, the story is no longer fresh.
Sector allocation is also much more skewed in EM than developed equities. The top three sectors in EM equities (energy, financials and materials) account for 51.5% of the MSCI Emerging Market Index.
In developed markets, seven of the 10 sectors have a weight greater than 10%, with the top three sectors accounting for 40% of the index. This sector concentration may be compounded by a higher proportion of firms coming from cyclical sectors and financials.
This may be another reason why EM equities have higher volatility, on top of the more systemic risk derived from being a less liquid, infant market.
In conclusion, we continue to have a slight bias for developed market equities versus emerging market equities.
This is based on valuation, lower expectations and so more room for positive surprises, greater sector diversification and the ability to tap into emerging growth through companies with established brands and models to drive shareholder value.
:: Andrew Miller is regional office head of Barclays Wealth in Newcastle
