This article is part of the Morningstar's Guide to Emerging Market Investing. Click here to find out just what an emerging market is and which hold the potential to grow exponentially - boosting your investment portfolio.
Emma Wall: Hello and welcome to the Morningstar series 'Ask the Expert'. I'm Emma Wall and here with me today is Chris Cole, Executive Partner at Towry. Hello, Chris.
Chris Cole: Good morning Emma, how are you?
Wall: Very well, thank you. How are you?
Cole: Excellent today. Thank you.
Wall: So we are here today to talk about the role that emerging markets should play in an investment portfolio. Broadly speaking what does emerging market exposure add to an investment portfolio?
Cole: I guess in the main you are looking for equity markets around the world to give you long terms growth potential, perhaps more than the western markets tend do so.
Wall: And depending on your investment horizon, that will, not always, but broadly dictate how much emerging markets exposure you should hold isn’t that right?
Cole: Yes, to a degree. Emerging markets will add potential growth to a portfolio but also potential volatility. So it's by getting the risk return correct for the investor, but obviously the longer you have to invest the more volatility you can expect to accept anyway.
Wall: This should never be the core part of a portfolio should it? Emerging markets are one of those ones that are periphery holdings.
Cole: Emerging markets are important I guess to most people's equity content. But they can never be a large percentage because of the illiquidity and the volatility they bring.
Wall: So then let's now look at the sort of ways that you can gain this emerging market exposure. Say you are young, you are just beginning to plan for the long term, say in a SIPP. What sort of percentage should you be looking at and how can I gain exposure to emerging markets?
Cole: I think the first thing is you look at your total equity content and if you are a long-term investor, maybe adding to on a regular basis around as a lump sum, you could easily be looking at 70% equity in total. It's quite a big portion. But then if you segment that down to the different geographical regions and emerging markets per se, you could easily be expecting to have sort of 10% of your entire portfolio in emerging markets.
Wall: And that’s part of a well-diversified portfolio.
Cole: Yes. I mean the key thing is, emerging markets have become more correlated over the years to western markets. So, whilst you're still getting the potential for that sort of kicker on the growth, you still get the volatility if the Dow (Jones Index) goes down.
Wall: And absolutely we have seen that correlation over last year. Ben Bernanke announced that the U.S. was going to taper its quantitative easing programme and actually it wasn’t the U.S. stock market that felt it the worst. It was the Fragile Five.
Cole: I think you have to sort of conscious of is, there is this globalisation that we have been through over the last 10 years. It's less obvious that emerging markets will give you the growth over and above anything else. And also you have got the currency issue too to think about. The dollar is primarily what a lot of these countries work against and if the dollar is strong does have an effect in emerging markets, et cetera.
Wall: So how does one gain emerging markets exposure?
Cole: Well I think there is two ways you could do it, well there are several ways you could do. But for a normal investor, you can either use a passive approach where you buy an index that tracks a basket of the emerging market economies or you can employ an active manager that can be more country-specific and both have their own merits.
Wall: And we’ve mentioned there the scenario for if I have a long term investment horizon. As I go towards retirement, what should I be doing with my emerging markets exposure?
Cole: In general terms if you go to finite points where you need certainty on the amount of capital you've got then you'd be tapering it down. So in our sort of more aggressive portfolios that 10% figure is the norm but that can easily be brought back down to 2% if you're someone who is sort of very close to needing the capital.
Wall: Chris, thank you very much.
Cole: You're welcome. Thank you.
Wall: This is Emma Wall from Morningstar. Thank you for watching.
