Emerging Markets as an Asset Class Is Broken – The Case for Unbundling

“Togetherness” is not always a good thing. Consider Emerging Markets equities, a broadly-defined asset class that has been disappointing over the past decade, posting returns practically at zero. The most commonly used reference index (MSCI EM) has annualized returns of 1.43% (3-year), -0.5% (5-year) and 0.38% (10-year). The contrast to US equities performance is stark: Emerging markets equities underperformed US equities by a staggering 376% over the past decade. According to S&P SPIVA research, active managers did not shoot the lights out either: Almost 80% of active emerging markets equity managers underperformed the broad index on a 5- and 10-year basis.

Consistently weak performance is not the only sign emerging markets is a broken asset class. EM groups together represent increasingly disparate economies in terms of size, culture, region, and stages of economic development. The economic outlook for most emerging market countries is bleak, with limited room for growth and long-term equity performance.

Many investors wanted to focus their EM exposure on the largest economies with similar growth prospects, which is why the sub-category “BRICS” (Brazil, Russia, India, China – and later South Africa) was invented. However, only China and India produced returns to justify this narrowing focus. The next logical step for investors is to fully unbundle their emerging markets exposure.

The pandemic and geopolitical tensions are now amplifying the call for unbundling. Russia is now completely un-investable and removed from the MSCI index. Latin America in general—and Brazil in particular—have seen a rise in populism and low prospects for economic growth. China has enjoyed strong economic growth over the past two decades, but Covid response and regional tensions have created global concerns over supply chain reliance on China. The obvious response is to diversify.

In this context India stands out as an opportunity that investors around the world should re-examine on a standalone basis. As a clear alternative to China, India offers significant cost advantages, an increasingly diversified manufacturing base, and a business-friendly government.

India, as well as Taiwan, are the stand-out performers among emerging markets equity markets. MSCI India has produced annualized returns of 13.28% (3-year), 7.69% (5-year) and 7.72% (10-year). The World Bank projects India GDP to grow by 6.5% in 2024, outpacing all major economies. In addition, there are local active managers with a history of significantly outperforming the broader Indian equity indices, particularly outside the Nifty Fifty.

With all this turbulence—and opportunity--it is time to unbundle emerging markets.