One of 2014's great investment surprises has been emerging markets equity performance. Notwithstanding negative news (from Ukraine to China, Turkey to Thailand) and record foreign investor outflows, MSCI EM equity is up 5% in the first half of the year in line with MSCI All Country World Index equity. Emerging market financial assets have been remarkably resilient; the question is why? The answer lies in the greatly underappreciated fact of emerging markets' domestic financial asset expansion.
A recent Boston Consulting Group report noted that from 2007 to 2011 assets under management rose at a 12% compound annual growth rate in Latin America and a 6% compound rate in emerging Asia vs. a flat result for North America and Europe combined. Analysis of this report together with figures from national authorities reveal that from 2002 to 2012, emerging market assets under management expanded by more than 150%, from roughly $2.5 trillion to $6.4 trillion, far exceeding developed market asset growth.
What's more, EM financial asset growth is set to accelerate in the years ahead driven by middle class expansion and wealth creation, coupled with maturing financial services industries. Ernst & Young LLP reports the middle class in emerging markets is poised to expand by roughly 3 billion people, or more than 40% of today's population, in the next 20 years. While it's hard to find data estimates for emerging markets AUM going out 20 years, PricewaterhouseCoopers LLP has forecast a doubling, to roughly $13 trillion, by 2020. So in less than 20 years, emerging market financial assets will have risen roughly fivefold, from $2.5 trillion in 2002.
This rising tide of middle-class wealth will accelerate the development of nascent mutual fund industries across emerging markets. World Bank figures indicate mutual fund assets as a percentage of gross domestic product for Turkey, Poland, China and India are all less than 5%. Mexico sports a less than 10% ratio. These levels are a far cry from more mature mutual fund industries in emerging nations such as South Africa and Brazil, with ratios of 30% and 46%, respectively, let alone the U.S. at 77% of GDP.