Should high net worth clients really risk exposure to emerging markets?

Emerging markets make up a growing slice of global GDP, and contain some of the fastest growing economies in the world. Indeed the World Bank predicts that emerging economies will grow at a rate of 4.5 per cent in 2018 and at an average of 4.7 per cent in 2019 and 2020.

But that does not necessarily mean that emerging market equities should subsequently increase as a share of investors’ portfolios, according to the Investment Strategy Group at Goldman Sachs.

“We aren’t that optimistic on emerging markets long-term,” explains New York-based Sharmin Mossavar-Rahmani, chief investment officer for Private Wealth Management at Goldman Sachs.

That is not to say that there are not opportunities in these countries, she explains, rather that these are investments which are not suitable for the type of private, high net worth client that Goldman is dealing with.

“Most of our high net worth clients have had their value creation stage – they may have built up successful companies, they might still have concentrated stock positions but have liquidated some value. Our goal for our clients, if we think holistically, is first to preserve that wealth, and then to grow it in a prudent way.”

These clients are not interested in “taking huge bets” on markets, though they might take some in private equity, says Ms Mossavar-Rahmani. “Our view is that emerging markets are not going to be a great place for them.”

As a result, a moderate risk portfolio we might have a two per cent allocation to emerging market equities.

This stance is nothing new for the firm. In December 2013 it published a note entitled “Emerging markets: As the tide goes out”, which highlighted what it termed the “structural fault lines” within these economies, highlighting issues such as impoverished populations, corruption and poor governance. The note focused on eight countries, Brazil, Russia, India, China, Indonesia, Turkey, South Africa and Mexico and argued they had not done anything to address these deficiencies, and that in some cases the situation was actually deteriorating.

“If these countries didn’t deal with their problems in the emerging markets ‘Goldilocks’ period of 2003 to 2007, then they are not going to deal with them unless they are forced to,” believes Ms Mossavar-Rahmani.

The Goldman report predicted that emerging markets could expect periods of underperformance and heightened volatility over the next five to 10 years.

Goldman’s recommended allocations to emerging markets were always on the low side, admits Ms Mossavar-Rahmani, and were reduced even further in 2013, when that paper came out, and then again a couple of years ago.

She simply sees too many issues clients would be better off avoiding. China, for example, which dominates the emerging market universe, has worrying levels of debt, explains Ms Mossavar-Rahmani.

“We think the debt levels in China are not sustainable. China is not a very rich country from a GDP per capita basis. How do they deal with all this debt, especially as growth is slowing down?”

When it comes to Russia, she points out the correlation between the economy and oil prices. “Do clients need to have exposure there with all that correlation? No, not really.”

There is also the fact that many of the biggest companies are state-owned enterprises, which tend to put the interests of the government ahead of those of its shareholders, she adds.

Fears overblown

Emerging markets have endured a torrid few months, but the case for investing in them remains strong, insists Jan Dehn, head of research at Ashmore Group. “The pullback in markets right now is temporary and mainly caused by massive profit-taking in euros, which in turn has led to profit-taking in emerging market FX after extremely strong returns in 2016-2017. The markets are overshooting to the downside, which is not unusual, but this excess weakness should not be confused for serious fundamental problems.”

President Trump’s “lurch” into protectionism has also impacted the emerging economies, admits Mr Dehn, but he believes the pullback is nearing the end.

“Investors will not take strong directional views over the summer due to low liquidity conditions, but once investors come back from the beach in September the markets will recover, possibly very sharply.”

Indeed, Mr Dehn claims that it is developed markets rather than developing which investors should really be worrying about.

“The US and other developed countries are falling further and further into populism and irresponsible fiscal policies,” he explains. These policies provide a “sugar high” for the dollar and stockmarkets, but ultimately undermine the case for both, insists Mr Dehn.

Meanwhile, emerging economies displayed resilience and undertook reforms during the massive headwinds they faced between 2013 and 2015, for example the halving of commodity prices, rising domestic bond yields, massive outflows and the 45 per cent rally in the dollar.

“This means that emerging market growth is cyclical and growth should level off at a higher sustainable level than before due to reforms,” he adds.