EM valuations are at a steep discount to the developed world, and we see potential in high quality names.
Despite stronger returns for international small and mid caps, many investors choose large caps.
Global trends like a growing middle class, an aging population, and the tech revolution should bolster growth.
Many investors are overweight in cash. A large cash or cash-like position can make sense for a short-term liquidity need, but otherwise, it can limit long-term growth potential. It may be a good time to step back and reevaluate clients’ portfolios to ensure they’re aligned with their long-term objectives. For those needing to diversify and add growth potential to their portfolio, we believe it makes sense to consider emerging markets (EM) and international small-mid- (SMID) cap stocks.
The Invesco Investment Solutions team anticipates emerging market stocks to outperform US and global equities over the next 10 years. Get the team’s thinking in their 2023 Long-Term Capital Market Assumptions.
EM stocks are evolving from a beta play on global growth to a source of alpha generation in a rapidly changing and uncertain world, according to Justin Leverenz, Chief Investment Officer for Developing Markets Equities.1 Government and corporate balance sheets have been in good shape, and EM valuations are at a steep discount to the developed world. His macro view is that a weaker dollar can bolster non-US equities. Plus, emerging market central banks are meaningfully ahead of the tightening curve, and he believes rate cuts may drive growth and asset prices. He also sees the potential for a post-pandemic recovery in China. The best way to access long-term growth in emerging markets, in his view, is by owning high quality, exceptional companies.
Read more about Justin’s active approach to EM.
Source: Morningstar, as of 12/31/22. Returns are based on monthly returns for the MSCI Emerging Markets Index, which is a free-float index that captures large- and mid-cap representation across 24 emerging markets (EM) countries. The MSCI EM Quality Index is a subset of the MSCI EM Index that looks to identify stocks with high quality scores based on three main fundamental variables: High return on equity (ROE), stable year-over-year earnings growth, and low financial leverage. MSCI EAFE® Index is an unmanaged index considered representative of stocks of Europe, Australasia, and the Far East. The index is computed using the net return, which withholds applicable taxes for non-resident investors.
Even if investors have international stock exposure, they typically favor large-cap stocks. The perception is that international SMID cap stocks are much more volatile. In reality, there’s not a dramatic difference. In fact, international SMID caps have historically generated stronger risk-adjusted returns. The average standard deviation is 16.19 for international SMID versus 15.59 for large caps.2 Interestingly, US investors are OK with US SMID caps. They allocate about 13% of their equity assets to them but less than 1% to international SMID caps.3 Too much focus on large non-US companies may mean investors miss out on the potential returns that SMID stocks can offer over international large caps. (See chart below.)
Read where our international SMID managers are finding opportunities.
Source: Morningstar, 3/31/23 data from the first full month of MSCI ACWI ex USA SMID Index returns, 6/30/07. International SMID caps are represented by the MSCI ACWI ex USA SMID Index. International large caps are represented by the MSCI ACWI ex USA Large Index. Past performance is no guarantee of future results. An investment cannot be made directly into an index.
There are more reasons to go global. Here are some trends that the Invesco Global Equities team expects to drive growth in global companies.
Beta is a measure of systematic risk with respect to a benchmark. Alpha is a measure of the difference between a portfolio’s actual returns and its expected performance, given its level of risk as measured by beta. Index returns are for illustrative purposes, and investors cannot invest directly in an index. Past performance is not a guarantee of future results.
Source: Average monthly rolling 5-year standard deviation (%), 6/30/07 – 3/31/23. Morningstar, 3/31/23 data from the first full month of MSCI ACWI ex USA SMID Index returns, 6/30/07. International SMID Caps are represented by the MSCI ACWI ex USA SMID Index. International Large Caps are represented by the MSCI ACWI ex USA Large Index. Emerging Markets are represented by the MSCI Emerging Markets Index. Past performance is no guarantee of future results. An investment cannot be made directly into an index. Standard deviation measures a fund’s range of total returns and identifies the spread of a fund’s short-term fluctuations.
Source: Morningstar, 3/31/2023. International SMID caps are represented by the Morningstar Foreign Small/Mid Value, Foreign Small/Mid Growth, and Foreign Small/Mid Blend categories. US SMID Caps are represented by Morningstar Small Value, Small Growth, Small Blend, Mid Value, Mid Growth, and Mid Blend categories.
Source: European Commission, “Developments and Forecasts of Growing Consumerism.”
Source: Oracle, “2020: Oracle’s Top 10 Cloud Predictions.”
Source: The United Nations, “World Population Ageing 2020 Highlights,” October 2020.
Electric vehicles and renewable power fuel emerging markets investment opportunities
The transition from fossil-based energy to renewable or clean energy production could drive the largest capex boom in history — and fuel investment opportunities.
Podcast: Are you ignoring these 13,000 growth opportunities?
We discuss misperceptions US investors may have about international small- and mid-cap stocks, and where our portfolio managers see opportunities in this often-overlooked space.
What is going on with Chinese equities?
Absent any major reforms, China’s economic growth is expected to be slower — but also higher in quality with competitive discipline, improved capital allocation and growing consolidation.
Important information
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Image: EschCollection / Getty
All investing involves risk, including the risk of loss.
Past performance does not guarantee future results.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.
Stock and other equity securities values fluctuate in response to activities specific to the company as well as general market, economic, and political conditions.
Stocks of small and mid-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.
The opinions referenced above are those of the authors as of August 18, 2023. These comments should not be construed as recommendations but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties, and assumptions; there can be no assurance that actual results will not differ materially from expectations.
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