Why Value Investing Is Making a Comeback in Emerging Markets
Value investing yields superior returns over the long run
Emerging markets have historically been a prime market for growth-oriented investors. After all, these economies are known for their rapid gross domestic product (GDP) growth compared to developed countries in Europe or the United States. As growth slows around the globe, as it has in 2019, it could create an opportunity for value investors to get involved overseas.
Let's take a look at why value investors may want to look at emerging markets, as well as some strategies for getting involved.
Benefits of Value Investing
Value investing has become increasingly popular in both developed and emerging markets. A large and growing body of evidence suggests that investing in stocks with below-average price-earnings or price-book ratios, or above-average dividend yields, provides superior returns over the long run. Successful investors like Warren Buffett have capitalized on these tendencies and generated exceptional above-market returns over time.
A paper published in Emerging Markets Review in 2002 showed that these tendencies carry over into emerging markets, with value stocks generating higher returns than non-value stocks. A subsequent Credit Suisse report found that value stocks outperformed in all but three of 21 emerging markets between 2000 and 2013, with the average value premium being 4.3% per year compared to just 3.1% in developed countries.
The risk profile of value stocks may also be attractive to many investors, including those interested in emerging markets. By purchasing equities at a discount, there is presumably less potential downside than a high-flying stock with few assets or earnings. There is also evidence that value stocks are no more volatile than high-growth stocks, which means that investors aren’t necessarily assuming a lot more risk in terms of beta.
Value Investing in Emerging Markets
Emerging markets experienced a significant downturn during the Great Recession in 2008, which worsened when the U.S. Federal Reserve announced that it would scale back its quantitative easing (QE) program and raise interest rates. Many emerging market currencies witnessed a significant decline in value. That made $2 trillion in dollar-denominated debt, used by many emerging market governments and companies to borrow, costlier to repay.
The dramatic decline in crude oil prices exacerbated these problems since many emerging markets lack the diversification of developed economies. Developing economies are, on average, concentrated in 50% fewer product categories than the developed world. When one of those fewer product categories is oil, the economies are hit harder by price drops. Crude oil accounts for a significant portion of economic output for countries like Russia and Venezuela, as well as most of the countries located in the Middle East.
These dynamics have led to significant capital outflows from emerging markets, which has depressed their valuations relative to developed markets. For example, the iShares Core S&P 500 ETF (IVV), which closely tracks the S&P 500, traded at a 20.98x earnings multiple on October 1, 2019, whereas iShare's ETF tracking the MSCI Emerging Markets Index (EEM) traded with a price-earnings ratio of just 12.18x. Value investors may, therefore, find emerging markets have more opportunities than developed markets.
ETFs, Mutual Funds, and Stocks
International ETFs represent the easiest and most cost-effective way to build exposure, given that they provide an entire portfolio in a single security—and often with lower expenses than comparable mutual funds. While there are many different emerging market ETFs to choose from, only a handful of them is focused on value investing opportunities. Most of these are so-called smart beta funds, which use alternative indexing strategies.
The most popular emerging market value ETFs include:
- FlexShares Morningstar Emerging Markets Factor Tilt (TLTE)
- iShares MSCI Emerging Markets Minimum Volatility (EEMV)
- SPDR S&P Emerging Markets Dividend (EDIV)
- WisdomTree Emerging Markets High Dividend (DEM)
There are arguably more mutual funds to choose from that are focused on emerging market equities, but most of these are actively managed, rather than passive (albeit smart beta) funds. Their expense ratios may also be significantly more expensive than ETFs, which means that it’s important for investors to consider whether the manager’s track record and other factors justify the higher fees.
Some popular emerging market value mutual funds include:
- T. Rowe Price Emerging Markets Value Stock Fund (PRIJX)
- Brandes Emerging Markets Value Fund (BEMIX)
Finally, investors can purchase individuals stocks as American Depositary Receipts (ADR) trading on U.S. exchanges, or as foreign stocks trading on exchanges abroad. Often, the easiest way to find these opportunities is to use a stock screener like FinViz to look for foreign stocks trading at discounted multiples or high-dividend yields. The downsides to this strategy are that it may be more expensive to build a portfolio, and many of these stocks are less liquid.
The Bottom Line
Emerging markets have historically been growth investor targets, but their recent downturn has created opportunities for value investors. When looking at opportunities, investors may want to consider value-orientated funds or screening for individual opportunities—while keeping mind the impact of higher expenses, liquidity, and other risk factors.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.