Buy and hold emerging market equities, says HSBC

Volatility in emerging market equities is at an all time high. However research from HSBC Global Asset Management shows that it pays to take a long-term view toward investing in this asset class, rather than trying to time the market.

Alex Tarver, Global Emerging Product Specialist at HSBC Global Asset Management, said the volatility of emerging markets is currently higher now than it was earlier in the new millennium (2000-2002), when this sector was reeling from the Latin American crises and the bursting of the technology bubble.

This rising volatility makes the timing of entering or exiting the market extremely important. However, this is difficult to do effectively and avoiding this asset class even in the short-term can have a significant longer-term opportunity cost.

Research from HSBC Global Asset Management - among the world's largest global emerging markets asset managers with US$86 billion (end June 2008) in this asset class - shows that missing only a good few days over the past decade can have a dramatic negative impact on returns.

Over the 10 year period ending 13 November 2008, investors' annualised returns would have been completely wiped off if they had missed the best 20 performing days of being invested in the MSCI Global Emerging Markets Index. While being fully invested over the full period would have resulted in an annualised return of 8.6% in dollar terms, an investor who was absent from the market for just the top 20 days would be left with a negative annualised return of -1.00%. Missing even the top 10 days would have resulted in a substantially low annualised return of 2.2%.

The opportunity cost is more extreme when considering single country exposure. For example, being invested in Russia over the full period would have resulted in a 22.5% annualised return, falling to minus 4.3% if missing the best 20 days. In Brazil, being invested for the full period would have led to an annualised gain of 16.0%, compared to -5.1% if out of the market for just the 20 best days. (Please note that past performance is not a guarantee of future performance).

Tarver said short term risks remained due to concerns about slowing global growth and credit related issues. Emerging markets were also bearing the brunt of geopolitical concerns, inflationary pressures, weaker commodity prices, and a stronger US dollar, he said. However, investors should take a longer-term view.

"Over the medium and long term, emerging market fundamentals appear to remain sound. Corporate and sovereign balance sheets within some emerging markets are at their strongest in recent history. Emerging markets are characterised by a large, young population, expanding labour forces and high saving rates that will drive long term growth. Meanwhile, inflation concerns are ebbing due to a reduction in food and energy prices," Tarver said.

Importantly, current valuations have resumed to attractive levels following a severe correction since the beginning of 2008. For example, the GEM universe is trading on a 2008 estimated PE of 7.8 times while EPS growth remains sounder than in developed markets. This varies substantially between countries. For example, the PER of Russia is currently 3.5 times, while China is 8.3 times and India 10.2 times.

Tarver concludes: "While there is clear evidence that investors are shying away from emerging markets, this is probably one of the most attractive entry opportunities for investors with a medium to long term view. There volatility is likely to continue in the near term, but it pays to be fully invested rather than trying to time the market."