AS JEFF APPLEGATE SEES IT, the case for investing in emerging markets could scarcely be stronger. Big developing countries like China, India and Brazil, along with often overlooked but strong ones like Chile, will probably generate 70% of the growth in global domestic product this year, says Applegate, the chief investment officer at Morgan Stanley Smith Barney. "Investing in emerging markets" he adds, "is like having a call option on that growth, and that's why we've been almost chronically overweight emerging markets" in recommendations for asset allocation.
Trouble is, not all the firm's affluent clients share the enthusiasm. "There is a subset of people who recall the emerging markets crises of the late 90s the Russian government defaulting on debt, and Asia's currency and markets collapsing and they are skeptical," says Brian Pfeifler, a managing director who works directly with some of the firm's ultra-high net worth individuals and families. "Some of our clients tell me they agree they might get a higher return, but they don't care. They have $100 million right now, and they don't want to go back to having only $20 million. And that's the risk they see in emerging markets."
Tension about just how actively to invest in the emerging markets and by what means is evident throughout the wealth management industry. Wall Street firms, banks and specialized investment firms have been sharply boosting their recommended allocations to these markets in some cases doubling them from last year. But many clients are resisting, fearful of exposing the family fortune to excessive risk. They worry about political instability in developing nations, lack of financial disclosure by overseas companies and notoriously volatile markets.
How these conversations play out could carry big implications for both the performance of families' portfolios and the growth of the top wealth management outfits. The top 40 firms, which Barron's ranks in the list below, look like they could use a little more growth. As of June 30, the group's total assets under management were up only 6% from those of the top 40 a year earlier half the gain of the broad stock market. Bank of America held on to the No. 1 spot, with $655 billion under management in accounts of $5 million or more. Morgan Stanley Smith Barney held on to No. 2 with assets of $536 billion in such accounts.
Playing the emerging markets right this year could make the difference between a mediocre year and a good one for both investors and their advisors. It will all come down to settling on the right allocation and then the right investment vehicles ETFs, foreign securities, shares of U.S. companies with overseas operations, or other instruments. None of those decisions is easy, especially if you're feeling wary of these markets.
IT'S NOT AS IF THE RICH don't have good reason to be more cautious than others when it comes to investing in emerging markets, or following any other relatively new investment strategy. In many cases these families are aiming to pass their money along, intact, to the next generation and possibly several generations more. Conservatism comes naturally when that is the goal. What's more, it's no secret that Wall Street has had its share of bad ideas in recent years; maybe investing in emerging markets is just the latest.
But fans of emerging markets maintain that not moving into emerging markets is what would be imprudent. Says Chris Hyzy, chief investment officer at the U.S. Trust division of Bank of America Merrill Lynch: "I would argue that the younger generations who will receive this money ultimately are going to need to grow that wealth, so passing up the opportunity is something that shouldn't be done without talking to the whole family about the issues, the way the world is transitioning and how the portfolio should reflect that," he says.
He suggests that wealthy families allocate at least 20% of the assets in their portfolios to emerging markets, and possibly as much as 35%. That's unquestionably at the high end of what wealth managers are recommending. But most are telling clients to get to at least 10% or 15%, up from a norm of closer to 5% several years ago.
For many private bankers, the key to convincing conservative investors to build positions in emerging markets is to show that a long-term structural change is under way in the world economy. In the second decade of the 21st century, investing in emerging markets is more than just a bet on the regions' turbo-charged economic growth. Rather, it's a way of offsetting excessive exposure to U.S. markets that appear trapped in a trading range; a home economy that, at best, may grow a few percentage points a year; and a domestic currency that seems doomed to lag as governments stagger under heavy deficits.
"In the last three decades, we here in the United States have been allowing our debt levels to climb; the flip side of that is what has been happening in the emerging markets, where the consumers and all the way up to the governments have much healthier balance sheets and often even boast of budget surpluses," says Hyzy. "At this point, however, investor trust levels still lag behind the fundamentals of the situation that this is the largest monumental shift in strategic direction we will see in this generation." He adds that "it's going to be a quick and dramatic shift to a world where the emerging markets will end up driving growth and the global economy as a whole, while the developed world tries to repair itself."
MANY INDIVIDUAL AND INSTITUTIONAL investors, eager to make up for losses during the financial meltdown and get a jump on the next "new new thing," have already clambered aboard the emerging markets bandwagon. Skeptics, for their part, make the case that dramatic economic growth in emerging markets isn't always easy to capture in the public securities markets.
For instance, while China's economy may grow by 9% or 10% a year, its stock market has been known to soar 70% in the space of a few months' time, only to collapse as speculative fervor drains away. Why, wealthy investors wonder, should they sign on for that kind of volatility? Particularly when, during the last crisis in the developed markets, financial markets in the emerging economies went down as much or more, and often just as rapidly.
Kevin Gardiner, head of investment strategy for Barclays Wealth Management, says he isn't suggesting that they rush into anything. "Historically, people become euphoric about emerging markets and every so often that is followed by a nasty outcome; I'm not convinced that we won't see another episode like that," he says.
Most investors, he says, shouldn't earmark more than 13% of their assets for the sector about the current weighting of the emerging markets, collectively, in the MSCI All Country World index. "Over time, we think it may make sense for them to lift that to about 15% to 20%, but that is as far as would be justified given the relative returns and the level of volatility."
Gardiner isn't bearish on emerging markets, but he does worry that one-sided enthusiasm for the sector has driven valuations in some markets to what he sees as high levels relative to developed markets. "A typical price/earnings ratio for stocks in the developed world is now below the 10- and 20-year average; in the emerging world, it's in line with that average, or slightly higher," he points out.
Of course, some wealthy investors are already prepared to be won over. Increasingly, they have made their money in businesses that have made them aware of the tremendous economic growth rates in China, other parts of Southeast Asia and stretches of Latin America. Whether that familiarity comes from outsourcing labor or developing new markets for their companies' products, the emerging markets story is one that has helped them to build their wealth to the point where they need the help of a private banker to manage it.
IT'S EASIER TO CONTEMPLATE a significant allocation to emerging markets today than it was a decade or so ago, thanks to the proliferation of exchange-traded funds and other investment products. In the first round of emerging markets mania, during the 1990s, the number of publicly-traded stocks in the regions was relatively meager. "A lot of what you could buy was limited to big telecommunciations companies and maybe a few big banks," U.S. Trust's Hyzy says.
Many more companies have matured to the point where they are viable choices. And ETFs, relatively cheap and easy to trade, give exposure to a range of industries and countries. Some, like SPDR S&P Emerging Markets offer access to the whole emerging-markets panoply, while others are more focused, like the MSCI Indonesia Investable Market Index (.
The bond market has also evolved; more nations now issue government debt that is denominated in local currencies, offering investors both high yields and protection from a declining dollar.
For the ultra-cautious, the best way into emerging markets may be to buy the stocks of American companies with substantial operations in the developing world. For example, Yum Brands has gained as the Chinese middle-class has discovered a taste for the company's Kentucky Fried Chicken. The drawback to this approach: giving up broad diversification.
No matter which investment vehicles you choose, it makes sense to seek out geographic diversification. China and India aren't the only promising markets, after all. Rebecca Patterson, senior investment strategist at JP Morgan Private Bank, points out that Indonesia has a growing middle class, a current accounts surplus, and an economy that will benefit from global demand for commodities.
Likewise, it's wise to avoid some countries altogether. Hyzy likes to "stay away from markets that are still in the 'teenage' stage, like those of many African countries." Markets like that have earned the label "frontier markets," and to many veterans of the emerging markets are viewed as offering the same kind of risk/reward tradeoff that Indonesia and Thailand did in the 1990s before the first great wave of emerging markets blowups.
Diversifying by asset class can also add protection. Rob Elliott of Bessemer Trust notes that there are now private equity funds in both Asia and Latin America that can give clients exposure to different kinds of businesses and remove some of the volatility associated with stock markets in China or Brazil.
"Real estate is another option," Elliott says. "Even a client who isn't comfortable with public markets can become comfortable with a real estate investment, since they are buying a hard asset."
WITH ALL THE CHOICES, IT'S LITTLE WONDER that bankers and their clients are spending a lot time on the issue. Patterson of JPMorgan says she used to meet with various clients two or three times a month about finding creative ways to boost their exposure to emerging markets; today, those are daily occurrences. "A lot of clients didn't realize there were so many different ways to get exposure to these markets," Patterson says.
Even when a family chooses to ramp up holdings in developing markets, little is gained by rushing. "No one is suggesting that it's appropriate to suddenly go from 10% to 50% of a portfolio in emerging markets," says Pfeifler of Morgan Stanley Smith Barney. Then again, it has clearly become an area of investing you ignore at your peril.