Investment Strategy Group
the recent swoon of emerging market assets
has led many investors to question whether this period of underperformance reﬂects a temporary cyclical downturn or the beginning of a long-lasting trend based on the signiﬁcant structural issues facing emerging market countries. We have called attention to the shared and speciﬁc fault lines of emerging markets for the last four years when making the case that US preeminence is intact and sustainable. We have repeated our belief that these
well-entrenched issues—covering the gamut from poverty and pollution to government interference and woefully inadequate infrastructure—were largely being dismissed in the rush to proclaim the rising power and inﬂuence of emerging market economies.So it should come as no surprise that we believe this recent bout of volatility and underperformance reﬂects a signiﬁcant reassessment of emerging market countries and the lack of progress they have made in addressing their fault lines. If anything, the task before emerging market leaders is even more arduous than before the ﬁnancial and economic crisis given that the macroeconomic tailwinds that boosted growth in the 2003–07 period have come to an end. Today, leaders in China cannot undertake needed reforms without running the risk of signiﬁcant economic and social disruptions. Combined with the prospect of increased capital outﬂows brought on by a reversal of monetary policy in the United States, this catch-22 situation will increase uncertainty around all other emerging market assets.We therefore encourage investors across the globe to revisit their strategic asset allocation to emerging market assets and brace for the strong possibility of signiﬁcant underperformance and heightened volatility over the next 5 to 10 years. While recognizing that some allocation to emerging market assets is warranted, we are lowering our allocation to emerging markets from a total of 9% to 6% for a moderate-risk client with a well-diversiﬁed portfolio. We also conclude that it is too early to overweight emerging market assets on a tactical basis, as they are not yet attractive enough from a valuation perspective.