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Emerging Markets: Following a Good Recipe & Using Good Ingredients

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It is helpful to think of a combination of asset classes--emerging markets, U.S. or international stocks, treasury or corporate bonds, cash, etc.--as a recipe. And think of the individual funds that you own as the ingredients being used in the recipe. Both matter a great deal. And both determine the net investment results from your portfolio and how the food you eat will taste.
 
Emerging markets as an asset class have been a better performer than either US or international developed markets in 2014. But over the prior three years Emerging Markets had fallen out of favor and an unsophisticated investor may have not had the patience to realize the increased expected returns.
 
 
"If anything, one should consider increasing their targeted allocation to emerging markets, precisely because they have had such a bumpy ride recently. After all, price and value are inversely related. While Kenny’s song doesn’t have lyrics to fit exactly this situation, you can at least eliminate the fold em’, walk away, and run options."
 
To boot, Dimensional Fund Advisors whose emerging markets mutual fund is utilized in True Wealth Design client portfolios to gain exposure to this asset class has been a top performer within the emerging markets category. From Bloomberg:
 
 "Dimensional's $4.7 billion Emerging Markets Small Cap Portfolio produced the highest risk adjusted return of 197 similar funds in the first half, according to the BLOOMBERG RISKLESS RETURN RANKING, by spreading cash across more than 3,000 stocks of small businesses in 17 countries from India to Brazil, while skirting Russia.
 
The fund, managed by Karen Umland and Joseph Chi, gained 1.2 percent when adjusting for price swings, double the return of the MSCI Emerging Markets Index.

 ...At the core of the philosophy is the idea that we think that in liquid, transparent markets, prices do a good job of reflecting available information,” Umland said. If sufficiently transparent and liquid, the market, rather than individuals, is best placed to determine the value of stocks." 

While I'm sharing this positive story to educate, let me be clear that I had no idea emerging markets would turn around when they did. Making a change to the recipe (allocation) like buying more emerging market stocks after their prices became depressed and undervalued on both an absolute and relative basis to other equity asset classes is something that is done with a 5+ year timeframe in mind. In the short-run the market is unpredictable. In the long-run, underlying value tends to be realized.

Nevertheless, a good investment process to construct a good recipe and fill it with good ingredients will pay off over time to the patient and disciplined investor. A little luck never hurt either.

To Your Prosperity,

Kevin Kroskey, CFP, MBA
 
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