Investors remain underinvested in emerging markets, if we consider portfolios on a GDP-weighted basis: the MSCI All Country World index allocates about 13% to emerging markets, and the emerging world accounts for about a quarter of the world's total public and private debt, but its share of global GDP is close to 40% and rising. That underinvestment is likely to continue to correct, especially as the emerging world becomes the main source of global economic activity in addition to just being the marginal driver of global growth.
Recent developments, from China's "Belt and Road" initiative to the expansion of local currency debt markets since the financial crisis and the inclusion of China's huge onshore equity and bond markets in global benchmark indexes, already point to this transition.
It is worth remembering the sheer scale of what is implied by the liberalization of China's onshore securities markets for international investors. In accordance with its sizable economy, China has the world's second-largest equity market by value. More than 4,000 publicly traded A shares are listed across various markets, with a total market capitalization of $12 trillion. The market in renminbi-denominated bonds that are traded and cleared onshore (the CNY market) is also worth almost $12 trillion, compared with just $82 billion worth of bonds in the U.S. dollar and offshore "dim sum" CNH markets combined. The renminbi is now the sixth-most traded currency in the world, its share of global foreign-exchange turnover having doubled since 2013.
Chinese A shares were included in the MSCI Emerging Markets index for the first time in June 2018, and following the launch of the Bond Connect trading channel in 2017, government bonds and policy bank notes are set to be included in the Bloomberg Barclays Global Aggregate index in April 2019. This will make it much easier for international investors to take exposure — indeed, it will mean additional benchmark tracking risk if they do not take exposure — and as such, these moves are expected to attract billions of dollars of inflows.
We expect international investors' engagement with emerging markets to become deeper as well as broader. As private markets begin to represent a greater proportion of economic activity in general, we also expect investment in public emerging markets to be complemented by bigger allocations to private assets. In fact, investors may perceive that genuine economic exposure to some emerging and frontier countries can be gained more easily through more domestically focused private companies than through public markets that can be extremely small and sometimes dominated by local champions that trade globally. Similarly, active managers' environmental, social and governance analysis is likely to penetrate deeper into securities research in emerging markets, not least because the major emerging countries' stock exchanges often have stricter reporting requirements than those in the U.S.
Over the coming decade, as lower return outlooks incentivize allocations to high-growth, high-return markets, we fully expect the current distinctions between the developed and emerging worlds to dissolve; investors are increasingly likely to reject this somewhat arbitrary division in favor of pursuing the best investment opportunities around the multipolar world.