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Investors: Getting the most out of emerging markets

Investors should diversify into developed market companies with high emerging markets exposures to capture these economies’ growth.

Stock market performance does not always equate with economic growth. Academic research shows that economies with the highest growth often produce the lowest stock returns.

The point is particularly relevant to emerging markets. The MSCI Bric index is only marginally outperforming the G7 markets this year, despite the contrasting growth rates between Brazil, India and China and the developed economies. The Bric markets are up 5.9% year-to-date in dollar terms, while the MSCI G7 index has risen 4.7%.

The dislocation between stock market performance and economic growth has several explanations. The universe of liquid, investable stocks in emerging markets is still limited. Brazil’s Petrobras, which recently executed the world’s biggest-ever stock offering, makes up nearly 15% of the MSCI Latin America index. Many emerging markets companies, often family-owned, remain private, meaning large chunks of the economy are unlisted.

Then there’s the issue of different classes of shares, favouring one group of investors over another. Petrobras, for example, has preferred and common stock. Government controls too make it difficult for equity investors to gain full value in many emerging markets.

Finally, there’s the problem of valuations. Some emerging markets appear to be getting frothy. Bombay’s stock exchange is trading at a price/earnings multiple of 24 times.

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