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Ins and Outs of Emerging Markets Investing

Recent history reminds us that emerging markets can be volatile and can lag developed markets. However, emerging markets represent a meaningful piece of the global investment opportunity set. A disciplined but flexible approach, which Dimensional has used for decades, can provide the means to access the emerging markets opportunity set effectively.

RECENT PERFORMANCE IN PERSPECTIVE

In recent years, the returns of emerging markets have lagged those of developed markets, with emerging markets underperforming US stocks by over 10 percentage points on an annualized basis over the past 10 years (see Exhibit 1). While recent returns have been disappointing, it is not uncommon to see periods when the reverse is true. For example, just looking back to the prior 10 years (2002–2011), emerging markets outperformed US stocks by more than 10 percentage points and other developed markets by 8 points on an annualized basis.

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The 50-Year Battle for a Better Way to Invest

Mac McQuown recruited me to help create the very first indexed portfolio in 1971. I was 24 years old and living in San Francisco, where more people my age were following the Grateful Dead than the stock market. The think tank Mac set up felt like a start-up, although it was long before anyone used that term. We were excited by the opportunity to turn academic research into a new way of investing. Many people thought we would fail. Some even called what we were trying to do “un-American.”

But we didn’t worry about the attacks; we focused on how indexing could improve the lives of investors. The fund offerings available at the time were actively managed portfolios that tried to outguess the market and were expensive, lacked diversification, and performed poorly. So-called star managers sold investors on their ability to win against the market; they sold products as opposed to solutions. Problem was, there was no compelling evidence they could reliably beat the market. We were confident that indexing—a highly diversified, low-cost investment solution that relied not on a manager’s ability to pick winners but on the human ingenuity of hundreds or thousands of companies—would change lives for the better.

Fifty years later, $9.1 trillion is invested in index mutual funds and exchange-traded funds (ETFs).1 This represents 51% of the total $17.9 trillion in equity ETFs and mutual funds. Six of the original academic consultants Mac hired to work on that first index fund went on to win Nobel Prizes. I have worked with four of them at Dimensional.

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Time the Market at Your Peril

Technology enables immediate access to everything wherever and whenever we want it. In many cases, such as staying in touch with friends and family, or learning about world events, that’s a good thing. However, when it comes to investing and money management, my fear is that faster and easier ways of investing will allow people to lose more money faster and easier.

As access to investing expands, it becomes even more important to adopt an investment plan that doesn’t try to actively pick stocks or time the market. The purpose of having an investment plan is so you can relax. So you don’t look at the market every day, stressing out and asking, “How’m I doing? How’m I doing?” Investors actively trading are not just potentially missing out on the expected return of the market—they’re stressed out, worrying about how the news alert they just received will impact their long-term financial health, and whether they can or should do anything about it.

I don’t blame people for this. The financial services industry has not done a good enough job educating investors that the best approach for their long-term financial well-being is to make a plan, implement it, and stick with it.

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What Drives Investment Returns? Start with Ingenuity

A recent news item reported that Frederick Smith intended to step down as Chairman and Chief Executive Officer of FedEx Corp., the largest air freight firm in the world.

 

As a Yale undergraduate in 1965, Smith wrote a term paper for his economics course outlining an overnight air delivery service for urgently needed items such as medicines or computer parts. His professor was not much impressed with the paper, but after a stint in the Air Force, Smith sought to put his classroom idea into practice. He founded Federal Express (now FedEx) in 1971, and one evening in April 1973, 14 Dassault Falcon jets took off from Memphis airport with 186 packages destined for 25 cities.

 

In retrospect, it was not an auspicious time to launch a new venture requiring expensive aircraft consuming large quantities of jet fuel. Oil prices rose sharply later that year following the Arab states’ oil embargo, and the US economy fell into a deep recession. Most airlines struggled during the 1970s, and Federal Express was no exception.

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Markets Don't Wait for Official Announcements

Some investors may worry about the stock market sinking after a recession is officially announced. But history shows that markets incorporate expectations ahead of economic reports.

  • The global financial crisis offers a lesson in the forward-looking nature of the stock market. The US recession spanned from December 2007 to May 2009.

  • But the official “in recession” announcement came in December 2008—a year after the recession had started. By then, stock prices had already dropped more than 40%, reflecting expectations of how the slowing economy would affect company profits.

  • Although the recession ended in May 2009, the “end of recession” announcement came 16 months later (September 2010). US stocks had started rebounding before the recession was over and climbed through the official announcement.

 

The market is constantly processing new information, pricing in expectations for companies and the economy. Investors who look beyond after-the-fact headlines and stick to a plan may be better positioned for long-term success.

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How to Invest Better - and Live Better

It can be challenging to start a conversation about investing. That’s why I encourage having a conversation before the investing conversation—what I like to think of as a “preamble.” Connecting life principles to investment principles is a powerful way to ground abstract principles in reality, and to connect over universal experiences and feelings. It can also help make sense of investment concepts often dismissed as overly complex for those who aren’t familiar with them.

Our lives are the cumulative result of the decisions we make every day. Just as in investing, the power of these decisions compounds over time. That’s why it’s so important to find a decision-making process that works for you—both in life and in investing. In my mind, this involves acknowledging that uncertainty can create both stress and opportunity, planning for what might happen rather than trying to predict what will happen, cultivating flexibility and adaptability, harnessing the power of compounding, and accepting your own limits. Embracing uncertainty by planning for the future can help you live life better now.

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