A steady 28% gain in the MSCI Emerging Markets index year-to-date, has many investors rethinking their exposure to the asset class. At a time when developed markets are thought to be entering the later stages of the current cycle — and as the S&P 500 index forward price-earnings ratio exceeds 18x projected earnings — emerging markets equities would seem to provide an obvious counterbalance for fundamental investors seeking diversification and value otherwise hard to find.
The difficulty, of course, remains the volatility inherent to the asset class. Even as the developed markets are just as susceptible to black swan events, the surprises in emerging markets are more common and often more pronounced. Investors were reminded of this in mid-May when Brazil's Ibovespa index fell 9% upon news that the country's president was being charged with bribery and obstruction of justice related to JBS SA's unfolding political-kickback scandal.
Put simply, actively managed liquid alternatives strategies are allowing investors who normally would not be able to stomach the uncertainty of emerging markets to potentially capture alpha from both up and down market moves. Moreover, in an era in which globalization and an accommodative monetary policy have large-cap stocks moving in lockstep across developed economies, emerging markets variable long/short funds provide an uncorrelated source of returns and protect against — while also potentially profiting from — the valuation, earnings and balance sheet risks common to emerging markets companies.
To be sure, the many draws that first attracted investors are just as evident today. It was around early 2000, for instance, that Goldman Sachs' seminal report on the BRICs familiarized the broader investment community with the compelling macro drivers fueling growth across Brazil, Russia, India and China. (More recently, Jim O'Neill, who coined "BRICs," has expanded this group to include the MINT economies, comprising Mexico, Indonesia, Nigeria and Turkey.)
In short, the macro case can be summed up by the disparity that still exists between developing economies' contribution to global GDP growth, representing 58% on a purchasing power parity basis, and the relatively scant 11% share that emerging markets stocks contribute to the total capitalization of the world's equity markets, based on data from the International Monetary Fund and MSCI Inc. Not to be overlooked is the steady expansion, as emerging market economies represented just 36% of total GDP growth in 1990, based on the same data, a percentage that has only gravitated higher in the nearly three decades since. From a demographic perspective, the projected working-age population and anticipated productivity growth would also seem to favor most emerging markets economies and should provide a tailwind for long-term investors.