Smart Allocation: Risks and Rewards in Emerging Market Investments

Especially if you live in South Africa and you've got some money invested in the local market , whether it's via a local index track or exchange traded fund or your local retirement fund , you have got exposure to an emerging market . But the question is should we have exposure to other emerging markets as well ?

And , if we should , how much of our investment should be allocated to other emerging markets ? And I think , just to explain , you know , when you look at some of these global index trackers , whether you buy it as a general equity fund or whether you buy it as an actual exchange-traded fund , it doesn't really matter .

I think it's to understand that the kind of name on the box is quite important here .

So when you buy something that says MSCI World and that's the name of an index and also a lot of products have that name in it MSCI World , you think because it's called MSCI World , you would think that that means what it says , in other words , that it invests in all the stock markets in the world .

But we're in financial services and we're talking about money and , of course , it's never as simple as it should be . So , unfortunately , what you need to know is MSCI world is basically developed markets , so it almost specifically excludes emerging markets .

So you're not really going to get exposure to China , to India , to South Korea , to most of South America , all of Africa , including South Africa . You're really just going to get US , canada , uk , europe , japan and a little bit of Australia and New Zealand .

So I'm sure I'm forgetting one of the developed markets there , but you get the message , you get the understanding . So if you want to buy an index tracker that actually invests in the developed and the emerging world as well , then you need to look at something called the All-Country World Index .

So , in short , when you hear the fund managers talk , sometimes they'll talk about the ACWI , a-c-w-i , the All-Country World Index . Now that gives you the index exposure to emerging markets as well , and the person who sent through the question says that they estimate that that's about 9% of the portfolio is allocated to emerging markets .

I haven't checked that , to be honest , but let's assume that that's correct . Then the question is , if you invest in the all country world index and you want one investment is if you invest in the all-country world index and you want one investment , is that enough emerging market exposure ?

And I think that what we need to understand is if you're going to just track an index , if you're just doing one thing , then going with the index weight to the emerging world is not a bad idea .

Remember that if emerging markets kind of continue to grow and the value of their stock market appreciates relative to the US especially , but also to Europe and the UK , then they will become a bigger part of the index , in which case , you know , you will enjoy some of that ride when you're an all-country world index investor .

I think also , just to know , though , that when you're buying stocks let's say , a global index tracker and it's got some exposure to the emerging markets directly , as we've just spoken about you've also got indirect exposure , because if you own a world index tracker , like an Acqui index tracker , you are also investing in shares like Microsoft , in shares like Pepsi

and Coke and Unilever and Johnson , johnson and BMW and VW and all of those and while they might be listed in the US or Europe or the UK they are selling an's growing population are in emerging markets . Then some of those big companies are making a big chunk of their money out of those markets .

So you know , buying Microsoft doesn't mean that you're only buying access to a company that only trades in America . It's a global business . You know , I do a lot of my emails and my meetings on a Microsoft product and I'm definitely not anywhere except in South Africa .

So you are getting a lot more exposure to emerging market economies than you would think when you're buying a global portfolio .

But if you feel that emerging markets are going to be the growth story of the next decade or the next 25 years and there is a good argument that a place like India is reforming itself and doing a very good job of becoming a better investment destination , then you might want a bit more exposure than the index weighting .

If you're going to do that I think I've written it in some of my books in the past . You know there is nothing wrong with pushing that allocation up . I think in your question you said that you thought maybe 25% to 30% felt like the kind of maximum correct number . I think that's probably right .

You know , for me , if I'm going to have emerging market exposure , I'm going to take a view and let it go to 25% or 30% as a maximum and just be careful then that if you start at 30% and emerging markets do incredibly well , you might need to rebalance .

You might need to sell some of your emerging market exposure into the future in favor of some developed markets . So just be careful that you don't necessarily start at your maximum allocation and then you're forced to do lots of trades later on which incur costs and potentially taxes for you .

So you can certainly take an all country world index and then top it up with an emerging market index if you want . If you're buying a global equity unit trust , you need to know that a lot of the time the global equity managers will have some exposure to emerging markets as well , but they're going to be a lot more selective .

So they're not going to just say well , south Korea makes up 3% of the world stock market , we're going to have 3% of our portfolio in South Korea . What they're most likely going to do is say we really like Samsung and we think it's a great business , the best electronics company around , so we're going to make that 5% of our portfolio . That's an example .

Or they might say we think the best semiconductor manufacturer in the world is in Taiwan .

It's called TSMC , and we're going to allocate a chunk of our money to TSMC and there's no way that Taiwan is going to be one of the world's largest economies , but TSMC is certainly the biggest manufacturer of semiconductors and might still be the biggest for many years , in which case you might take a view , if you're a fund manager , on TSMC and so just

understand that a global equity fund might have very specific views on very specific companies and therefore they might not care too much about the benchmark weightings , in other words , the index weightings .

They're going to be more focused on what are the future businesses , what are the great businesses that they think will generate a return , and they might then have a bigger weighting to emerging markets . If they don't like the regulatory kind of environments of emerging markets , stock exchanges , they might have nothing in emerging markets .

There are a lot of fund managers that used to be quite bullish and quite optimistic about earning Chinese shares , but a bunch of those fund managers are now completely sold out of China .

Why Not because they believe that the Chinese economy is going to be in the doldrums for the next two decades , not because they believe that the Chinese economy is going to be in the doldrums for the next two decades .

It's more about the fact that they believe the Chinese government has overregulated the stock market and actually become kind of punitive to stock market investors in general and very specifically to kind of dollar based investors . So you know , you've just got to be careful when you make a call like that that you're going to be in emerging markets .

You know the geopolitics play a big role in investment decisions . You know if the regulatory environment in South America goes kind of you know , more and more pro-business , pro-growth , pro-business kind of mentality , then you might want to overweight your exposure to South Africa , which might be a great call in the next decade .

It hasn't been the best call in the last decade . So I think you need to understand that there's so many dynamics when you're making these decisions and you might want to track the index or you might want to pay a fund manager to be very specific in their views and a bit more dynamic than you could be with your investment decisions .

I hope that helps and thank you so much for your questions . We love those questions . Please keep them coming .