After the first months of uncertainty, the shares of Emerging Countries have started to run again. The timely intervention of central banks to limit the depreciation of local currencies, the easing of tensions between Russia and Ukraine and the easing of the credit crisis in China seem to have convinced investors to return to these markets.
In fact, it has been four months now that the stock indices of emerging countries have outperformed the stocks of developed countries (+13,1% against +5,4%). It hasn't happened since September 2012. Often investing in emerging market stocks collides with the desire not to risk too much. But is it really so? Are emerging countries really riskier than developed countries?
Our analysis
We have talked several times about the concept of risk and among the many descriptive metrics that the Advise Only "super-calculator" offers (free of charge) to its users, there is the Max DrawDown. This is a risk indicator that measures the maximum loss generated by a variable (in our case, the stock market of Emerging Countries) over a period of time.
In the graph below, I have compared the historical Max DrawDown, ie effectively realized, of the MSCI Emerging Countries stock index, with respect to the same indicator calculated for the stocks of Developed Countries. In this case, the Max DrawDown quantifies the maximum loss that an investor could have suffered over a period of one year. What does the graph suggest?
The stock markets of Emerging Countries were actually more risky, as:
- from 1991 to today, for about 80% of the time, equity investment in Emerging Countries has generated a maximum loss greater than that of Developed Countries;
- the moments of greatest losses were concentrated during the Asian crisis (-54%) and mortgagessubprime (-ten%);
- up until yesterday, the Stock Exchanges of Emerging Countries continued to generate a maximum loss greater than that of Developed Countries.
This highlights that, despite the acceleration of the market and the improvement in the financial climate, we must not forget how burned we could have been until yesterday.
So what to do with emerging countries?
We have always held emerging market equities in our Express Portfolios, albeit in varying proportions. And as the investment opportunities became more interesting, we first increased exposure to equities (asset allocation of December 2013) then, taking advantage of the increase in yields, we also exposed ourselves to emerging market bonds (asset allocation of March 2014).
The reasons for this change?
First of all, with the January-February reversal, valuations (ie prices valued against fundamentals) had become too attractive to ignore. Furthermore, the fundamentals of emerging countries as a whole have never been questioned and the progressive improvement of the Emerging Countries Risk Barometer convinced us that the time had come to invest. Always in compliance with our cardinal principles: diversification and active risk management. In short, invest yes, but always with caution.
For those who wish to invest a small portion of their assets in Emerging Countries, I have created an investment portfolio: Emerging Markets. Enter our website to discover its composition!
