It is not too late to get on board the big theme of a shift in world growth away from the developed and towards the developing world, but super funds should be aware of costs and risks in some investment sectors of emerging markets, according to Watson Wyatt.
The asset consultancy today released a research note suggesting a medium-long-term allocation to equities, debt and currencies in emerging markets, where exposure to the macroeconomics dynamics will be most readily obtained.
“The starting point for gaining exposure to emerging economies should be via asset classes that are correlated to the macro trends, are liquid, have higher capacity and have relatively low transaction costs and manager fees,” said Jeffrey Chee, investment consultant at Watson Wyatt.
The firm said that institutional funds should allocate capital in emerging market equities because high economic growth and high returns on capital can deliver outperformance. The long-term improvement in the economic fundamentals of those markets should lead to higher credit quality, lower yields on bonds, appreciation of currencies and improved liquidity of debt.
It recommends investors to have exposure to a long-term dynamic basket of emerging market currencies, funded in G4 currencies, Yen, USD, Euro and Sterling.
“This would provide direct long-term exposure to higher relative productivity growth in emerging countries and world rebalancing themes.’
According to the new research paper, ‘Emerging Wealth’, real estate is reasonably correlated with GDP growth, but markets are highly heterogeneous and some markets are relatively immature.
“Institutional investors face significant complexity and potentially high fees when trying to build a portfolio that captures this long-term trend [emerging market economy to grow strongly] and should also recognize the governance implication of following such a strategy,” said Chee.
The report said that many private equity managers are positioned well to generate returns by helping portfolio businesses develop and grow.
“[We] have a preference for growth capital over buyouts,” it said.
In relation to the high level of spending by emerging countries on new infrastructure projects, the firm says that there will be a wide range of outcomes for foreign private providers of capital.
“Some investors may choose to access infrastructure through the indirect exposure of developed and local market equities and others will seek, benefit from, more direct forms of investment,” it said.
Watson Wyatt said that emerging economies need to meet a number of conditions to achieve high, long-term growth. These include stable monetary and fiscal objectives and inflation-targeting, the provision of education to provide skilled workers, the adoption of new technology to drive capital efficiency, as well as a robust legal system.