In an abrupt historical shift, emerging markets appear stable relative to developed markets, which are suffering from political and economic issues that used to be the hallmark of emerging markets. Factor in robust growth relative to developed markets and it is easy to see why investor enthusiasm for emerging markets remains strong.
In spite of this relative stability and growth, issues that have traditionally plagued emerging markets have not totally disappeared. Increasing inflation has been forefront in the news, but more embedded limitations remain. Many markets impose trading restrictions on foreign shareholders. The rule of law, securities regulation and accounting transparency typically lags developed markets.
In addition, the large and liquid emerging stocks that dominate general and country-specific emerging market ETFs are oriented toward gyrations of the global economy rather than their local markets. Many of these stocks can be directly or indirectly influenced by their governments. The top five stocks in the iShares Emerging Markets Index Fund (EEM) highlight this point. In order, they are: Samsung, Gazprom, Petrobras, Vale and China Mobile, all of which have fortunes tied to the health of the general global economy or might not operate independently from government influence.
Advisors who are looking to gain access to the growth of emerging markets would be prudent to look at smaller market capitalization stocks that are more heavily geared towards growth in emerging markets. But these stocks are not readily available directly on emerging market exchanges, due to concerns about corporate governance, accounting, liquidity and, recently, valuation.
An Alternative Way to Invest in Emerging Asia
To combat these issues, advisors should seek out investment managers who can identify profitable companies with strong asset backing and limited leverage that might be underfollowed or misunderstood by the market. It is also important for the investment manager to purchase stocks below a reasonable estimate of net tangible asset value to protect on the downside while using a range of qualitative research techniques to determine how much upside an investment might generate. This investment style tends to provide strong downside protection in a declining market and upside participation in an ascending market.
This process has yielded an alternative and exciting way to invest in emerging markets. Smaller capitalization stocks listed on the well-regulated and established Asian bourses often times are directly or indirectly emerging markets stocks. Prime examples of these opportunities abound on the stock exchanges in Tokyo, Singapore and Hong Kong. Within these markets it is possible to find value securities that are heavily geared toward emerging market growth. These stocks are often unencumbered by government influence and led by entrepreneurial managers who have their “skin in the game” via stock ownership.