Why Is Value Investing Returning to Emerging Markets?

Over time, value investing produces higher returns. Historically, emerging markets have been a popular choice for growth investors. After all, when compared to developed countries in Europe or the United States, these economies are known for their rapid gross domestic product (GDP) growth. As global growth slows, as it did in 2019 and 2020, value investors may have an opportunity to invest in emerging markets. Here are some reasons why value investors should consider investing in emerging markets and some ways to get started.

Important Points to Remember

  • In emerging markets, value investing may produce above-market returns.
  • High-growth stocks may also be less volatile than value stocks.
  • Stocks, exchange-traded funds (ETFs), and mutual funds can all be used to invest in emerging markets.
  • Emerging market exchange-traded funds (ETFs) are frequently the simplest and most cost-effective way to invest in these markets.

The Advantages of Value Investing

In both developed and emerging markets, value investing has grown in popularity. A growing body of evidence suggests that stocks with lower-than-average price-earnings or price-book ratios, as well as higher-than-average dividend yields, provide better long-term returns. Warren Buffett and other successful investors have taken advantage of this to earn above-market returns over time. In a paper published in Emerging Markets Review in 2002, it was shown that these tendencies carry over into emerging markets, with value stocks outperforming non-value stocks in terms of returns. Between 2000 and 2013, value stocks outperformed in all but three of 21 emerging markets, according to a Credit Suisse report, with an average value premium of 4.3 percent per year compared to just 3.1 percent in developed countries. Many investors, including those looking to invest in emerging markets, may be drawn to value stocks because of their low-risk profile. When compared to a high-flying stock with few assets or earnings, buying shares at a discount presumably has a less potential downside. There's also proof that value stocks are less volatile than high-growth stocks, implying that investors are taking on less beta risk.

Emerging Markets Value Investing

During the Great Recession of 2008, emerging markets took a big hit. The situation worsened when the Federal Reserve of the United States announced that it would reduce its quantitative easing (QE) program and raise interest rates. The value of many emerging market currencies has plummeted. As a result, repaying dollar-denominated debt, which many emerging market governments and companies use to borrow, becomes more expensive. By 2020, this type of debt will have grown to $4 trillion. Because many emerging markets aren't as diverse as developed economies, the sharp drop in crude oil prices exacerbated the situation. In comparison to the developed world, developing economies tend to be more concentrated in fewer product categories. The economies are hit harder by price drops when one of those products is oil. Crude oil is a major source of revenue for countries like Russia and Venezuela, as well as the majority of Middle Eastern countries. These factors have resulted in large capital outflows from emerging markets, lowering their valuations in comparison to developed markets. On January 7, 2021, the iShares Core S&P 500 ETF (IVV), which closely tracks the S&P 500, traded at a 25.55x earnings multiple, whereas the iShares ETF tracking the MSCI Emerging Markets Index (EEM) traded at just 18.30x. Emerging markets may offer more opportunities for value investors than developed markets.

Stocks, ETFs, and Mutual Funds

You can invest in emerging markets in a variety of ways, including stocks, ETFs, and mutual funds. International exchange-traded funds (ETFs) are the simplest and most cost-effective way to diversify your portfolio. This is due to the fact that they offer a complete portfolio in a single security. Furthermore, they frequently have lower fees than comparable mutual funds. While there are numerous emerging market ETFs to choose from, only a few of them are value-oriented. The vast majority of these are "smart beta" funds, which employ alternative indexing strategies. The following are the most popular emerging market value ETFs:
  • Morningstar Emerging Markets Factor Tilt FlexShares (TLTE)
  • Minimum Volatility iShares MSCI Emerging Markets (EEMV)
  • Dividend-paying SPDR S&P Emerging Markets (EDIV)
  • Emerging Markets High Dividend WisdomTree (DEM)
There may be more mutual funds that focus on emerging market stocks to choose from. However, most of these are actively managed rather than being passive funds. Their expense ratios may also be significantly higher than ETFs. That means you should consider whether the manager's track record and other factors make the higher fees worthwhile. The following are some of the most popular emerging market value mutual funds: Finally, investors can buy individual stocks such as American Depositary Receipts (ADRs) traded on US exchanges or foreign stocks traded on international exchanges. Using a stock screener like FinViz is often the simplest way to find these stocks. Look for foreign stocks with low price-to-book ratios or high dividend yields. The disadvantages of this method include the possibility of higher portfolio costs and the fact that many of these stocks are less liquid.

Final Thoughts

Emerging markets have long been a favorite of growth investors, but their recent downturn has also opened up opportunities for value investors. You might want to look for value-oriented funds or screen for individual stocks when looking at stocks and funds. Keep in mind, however, the effects of higher costs, liquidity, and other risk factors.

Most Commonly Asked Questions (FAQs)

What is the definition of an emerging market?

Although there is no universal definition for emerging markets, different governments and organizations often use similar terms. According to USDA programs, an emerging market is a country that is "moving toward a market-oriented economy." Morningstar analysts compare gross national incomes per capita to identify emerging markets.

Is there a Vanguard Emerging Markets Value Fund?

The Emerging Markets Select Stock Fund is one of Vanguard's emerging market funds (VMMSX). This fund employs fundamental analysis, but it isn't a true "value fund" because it doesn't invest solely in value stocks.

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