Emerging markets look cheap. Or is Europe the true pocket of opportunity? Or perhaps Japan's current rally has staying power?
Investors may have recently heard various market experts suggesting that foreign stocks have better upside potential than U.S. names. The most straightforward way to potentially profit from such an idea is to simply boost a portfolio's exposure to a broadly diversified global-stock fund – whether an actively managed offering or index fund – and call it a day.
But how about for investors who would like to be more opportunistic, perhaps giving a slight tilt to truly undervalued foreign-domiciled names while de-emphasizing the parts of foreign markets that appear to have less upside potential? Which portfolio additions will give them the biggest bang for their rebalancing buck?
In that case, there appears to be some smart money converging around emerging-markets stocks. But enthusiasm for emerging markets isn't universal, based on a survey of the weightings of Morningstar's top-rated actively managed foreign-stock funds. While some of Morningstar's Gold-rated offerings currently have heavy weightings in emerging markets – including more exotic markets like Africa and the Middle East – other well-regarded funds are sticking with developed markets, primarily in the U.K. and Europe. (Interestingly, nearly all of the Gold-rated active funds are currently downplaying Japanese equities – a rare point of consensus among all of these top-rated offerings.)
The Case for Emerging Markets
True believers in reversion to the mean would probably tend to favour emerging markets – or at least a broadly diversified global fund that includes ample exposure to them. After all, the MSCI Emerging Markets Index has gained just a bit more than 1% on an annualised basis during the past five years. Meanwhile, the MSCI EAFE Index – which excludes emerging-markets stocks – has gained about 6% annualised during the past five years.
Asset-allocation guru Bill Bernstein asserted last autumn that emerging-markets stocks look relatively undervalued. GMO's co-head of asset allocation, Ben Inker, recently stated that emerging markets – and particularly the value stocks within emerging markets – look inexpensive relative to developed-markets names. On the flip side, developed-markets stocks – even those of European firms – have actually performed pretty well over the past several years.
Emerging Markets? Not So Much
But before investors get carried away with the notion that emerging markets are the place to be, let's look at some countervailing evidence. While four of Morningstar’s highest rated global stock investors were emphasising emerging-markets names as of their most recently available portfolios, another four Gold-rated offerings had emerging-markets weightings that were in line with, or lower than, their category peers.
So, even though emerging markets may be cheaper than they have been in the past, these managers don't consider them especially attractive on a bottom-up basis right now.
What Can Investors Do?
Investors can approach the data in a variety of ways. They can simply buy – or stick with – a broadly diversified, actively managed global equity fund and entrust that manager with the decision about how much emerging-markets exposure to hold at any given point in time.
Alternatively, they can look a foreign-stock index fund – either a traditional index fund or ETF – that includes exposure to emerging markets. Finally, investors who would like to exert more direct control over their emerging-markets exposure might pair a developed-markets index fund with one focused on developing markets.
This article has been edited for a UK audience. The original article appeared on Morningstar.com for US investors.
