International Equity – US Funds vs. Emerging Markets Equity Funds
For us Indians, international investing involves investing in securities of companies that are listed in a foreign market. You can invest in shares of foreign companies either directly by opening a trading account with a stockbroker or through international mutual funds provided by Indian AMCs. For international equity investments, the investor community usually divides its investments into two major categories: Developed markets and emerging markets.
The developed markets are those where a lot of economic development has already happened, and the current growth rate is low. On the other hand, the emerging markets are those where economic development is currently happening, and the current growth rate is high.
For the purpose of this article, we will limit the scope of developed markets just to the US economy. In this article, we will do a performance comparison of international equity: US funds vs. Emerging markets equity funds.
What are developed markets and emerging markets?
Developed markets are those where:
- A lot of economic development has happened,
- There is better infrastructure and connectivity in terms of airports, roads, mass rapid transport systems,
- There are better healthcare facilities,
- The capital markets are more mature and efficient,
- The household incomes of individuals are high, and the standards of living are high.
The developed markets constitute countries like the United States, Canada, United Kingdom, Germany, France, Japan, Australia, etc.
Emerging markets are those where:
- A lot of economic development is currently happening,
- The infrastructure and connectivity is built to some extent with a lot more potential in future,
- The healthcare facilities are far and few,
- The capital markets are yet to mature and become efficient,
- The household incomes of individuals are low and the standards of living are low.
The emerging markets include Brazil, Russia, India, China, South Africa, grouped as BRICS nations. Other emerging markets include Taiwan, South Korea, Malaysia, Philippines, Portugal, Spain, Italy, Ireland, and some African and Middle East economies.
Comparison of developed markets and emerging markets
In the above section, we understood the concept of developed markets and emerging markets in general. Now let us compare developed markets and emerging markets on certain parameters from an investment point of view.
|Parameter||Developed markets||Emerging markets|
|Level of economic development||High||Low/medium|
|State of economy and society||Developed/stable||Transitional/unstable|
|Macroeconomic framework||Developed/stable||Under development (being created)|
|Market institutions||Developed||Under development (being built)|
|Market conditions||Stable||Not stable to the extent required|
|Market infrastructure||Developed||Under development (being build)|
|Government involvement in business||Not so high||Relatively high|
|Cultural resistance to the market economy||Low||Higher|
|Rate of economic growth||Low||Higher|
|Room for economic growth||Narrow (as markets are mature)||Huge (as markets are still developing)|
Investing in developed markets and emerging markets
In the above section, we did a comparison of developed markets and emerging markets. Now, let us understand how we can invest in these markets and the kind of returns that these markets have given in the past.
Benefits of investing in developed markets: From the above section, it is clear that developed markets are mature, stable, and efficient. Because of these benefits, developed markets usually trade at a premium valuation as compared to emerging markets. While these benefits of developed markets are noteworthy, investors should understand that the current level of economic development in developed markets is low, and the room for future economic growth is also narrow.
Benefits of investing in emerging markets: In emerging markets, the market infrastructure is being created, the economic growth rate is high, and the room for economic growth is huge. Due to these benefits, emerging markets have provided investors good returns in the past and have the potential to do so in the future. Hence, many investors have emerging market investments as a part of their core portfolio.
For deciding on whether to invest in developed markets or emerging markets, you need to consider their valuation which is measured through parameters like price-to-earnings (PE) ratio. The PE ratio tells you how many years of accumulated earnings will it take to equal the cost of investment based on the company’s current earnings. The PE ratio tells you whether the company is overvalued or undervalued or fairly valued.
Price earning (PE) valuation comparison of emerging markets and US markets | (Source: https://www.vaneck.com)
As seen in the above chart, the developed market indices trade at a premium valuation compared to emerging markets. It is mainly because developed markets are mature, stable, and efficient, even though emerging markets have higher growth potential. Emerging markets carry risks of political uncertainty, Government interference, scams, civil unrest, etc., so investors assign them lower valuations.
In the previous section, we understood the benefits of investing in developed markets and emerging markets and why developed markets trade at a premium valuation. Let us now compare the returns given by US markets and emerging markets.
Performance comparison between US and Emerging Markets
Before we compare returns of the current economic cycle, let us look at the cyclical nature of the relationship between US markets and emerging markets' returns.
Cyclical nature of the relationship between emerging markets and US markets
As seen in the above table, the emerging markets and US markets work in cycles and take turns to outperform each other.
- During the 6-year cycle (1988-1993), the emerging markets outperformed the S&P 500 Index (the major US index) by a big margin.
- During the next 5-year cycle (1994-1998), the S&P 500 Index outperformed by giving positive returns of 194%. On the other hand, the emerging markets saw a serious bout of correction and went down by 39%.
- During the next 9-year cycle (1997-2000), the emerging markets once again outperformed by giving returns of 420%. On the other hand, the S&P 500 Index gave returns of just 38% during the same period.
- During the current ongoing cycle (2008-2020), the S&P 500 Index has outperformed by giving returns of 191%. The emerging markets have managed to give returns of just 23% during the same period.
- In the current year, as of August 2021, the S&P 500 Index continues to maintain its lead over emerging markets by giving superior returns.
It remains to be seen how long the current cycle continues before the emerging markets take the lead.
Current cycle: Comparison of returns between US markets and emerging markets
In the earlier section, we have seen how the US markets and emerging markets have taken turns to outperform each other. Now let us focus our attention on the current cycle in which the S&P 500 Index has outperformed the emerging markets by a big margin.
Note: The above data is in USD terms, and as of May 2021
The above chart shows that The S&P 500 Index has outperformed the MSCI (Morgan Stanley Composite Index) Emerging Markets Index by a big margin. Assume you invested 100 USD in each: S&P 500 Index and MSCI Emerging Markets Index in 2008. As of May 2021, your S&P 500 Index investment would be comfortably above 250 USD. On the other hand, in US Dollar terms, the MSCI Emerging Markets Index has given very low returns, and hence you wouldn't have made much money on your investment.
|Index||Year to date||1 year||3 years||5 years||10 years|
|S&P 500 Index||17.99%||36.45%||18.16%||17.35%||15.35%|
|MSCI Emerging Markets Index||0.22%||20.64%||7.93%||10.37%||3.61%|
Note: The above S&P 500 Index data has been sourced from S&P 500 (USD) Factsheet from the www.spglobal.com website. The above MSCI Emerging Markets Index data has been sourced from the www.msci.com website. The data for both indices is as of 30th July 2021. The 1-year returns are annualised. The 3, 5, and 10-years returns are CAGR.
The above table shows that the S&P 500 Index has given superior returns than the MSCI Emerging Index over 1, 3, 5, and 10 year periods. If we observe the current year (2021) performance also, as of 30th July 2021, the S&P 500 Index (17.99% returns) has outperformed the MSCI Emerging Markets Index (0.22% returns). It remains to be seen for how long the current cycle of S&P 500 Index outperformance continues and when emerging markets will make a comeback.
Investing in the International equity funds
Appropriate asset allocation requires an investor to have a mix of equity, debt, and gold in their investment portfolio. You should split your equity portfolio further among domestic and international equity mutual funds. You can have a portion of your equity portfolio allocated to international equity mutual funds.
With the Glide Invest App, you can get the recommendations for the best domestic and international equity mutual funds based on your risk profile. You will get advice on how to plan and systematically invest towards your financial goals. With Glide Invest, you will get guidance for:
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