When it comes to investing in emerging markets, there's a fundamental difference in attitude between international clients and U.S. clients, says Ramzi Nuwayhid, a Boston-based private wealth advisor at Merrill Lynch's Private Banking & Investment Group.
"On one phone call, I have an international client telling me the markets are down 15% and he thinks it's the best value he's seen in a long time in certain emerging markets," Nuwayhid say. "On another phone call, there's a U. S. client who is very worried and wants to sell the position."
Nuwayhid is accustomed to the dichotomy between U.S. and international perspectives. He was born in Beirut, Lebanon, and moved to the United States in 1987 when he was 13. Six years later, he began pursuing a career as a financial advisor. Today, Nuwayhid's practice reflects his international background. Frequent trips to both Beirut and Dubai to visit family have contributed to a large international client list, including immigrants and expats, that makes up about 25% of the families his practice serves. His team's clients typically include executives of public and private companies and their families with $10 million or more in assets.
Nuwayhid has long been bullish on emerging markets because of their long-term growth prospects, due in part to a surging middle class in these countries. He remains bullish today, despite the drop in the asset class sparked by Federal Reserve Chairman Ben Bernake's comments on tapering on May 22. Unfortunately for Nuwayhid and other advisors who believe in emerging markets' prospects, this drop has made it even more of an uphill battle to get U.S. investors to increase their exposure. This reticence is a combination of living in a stable cultural and economic environment, ingrained cultural perspectives, historic sensitivities and unfamiliarity with the emerging regions. The result: U.S. investors are missing what these advisors think is an unprecedented opportunity.
"The headlines and the fear out there are just a reminder that it's a volatile asset class," says Laura Thurow, director of private wealth management research at Robert W. Baird & Co. "Even though it's more volatile, it can still be a good diversifier in a client portfolio, because it ebbs and flows a bit differently. We still like it as an asset class."
Identifying the Opportunities
Despite the current downturn of emerging markets equities, this asset class still holds selective opportunities, experts say. Fundamental growth drivers are still therethe worldwide middle class population is projected to double to two billion by 2030, bolstered by growth in the developing and frontier markets, according to a recent report from Merrill Lynch Wealth Management. The emerging markets already account for 40% of investments and more than half of GDP growth internationally, the report says.
"Some of these countries and economies are growing faster and they're beating us," says Daniel I. DeMoss, CEO of the Turner Group and a wealth advisor at Raymond James in Tulsa, Okla. "Demographically, they have the right mix."
But as promising as these asset classes are, there is more than just Bernake's comments at work in driving them lower. Brazil, Russia, India and Chinaknown as the BRIC countriesare experiencing serious challenges, says Patricia Oey, senior analyst of passive fund research at Morningstar. The economics of Brazil and Russia, in particular, are highly tied to commodities, which do not do as well in a slowing global growth environment. India and Brazil are slow to push through necessary reforms to resolve the infrastructure and labor issues weighing them down. Political unrest threatens other countries like Turkey, Egypt and South Africa.
Meanwhile, Oey adds, investment opportunities lie in countries like Mexico, which can prosper with improvement in the U.S. economy. Countries in Southeast Asia are also showing good fundamentals with healthy banking systems and government finances, she says.
The diversity within the emerging markets asset class has left Robert Sechan, managing director at UBS Wealth Management, with the challenge of coordinating his team's short-term cautious view on the asset class (due to the belief that growth in the short term will not be as robust as that predicted by consensus earnings estimates) with positioning clients to take advantage of the anticipated long-term growth in the sector. Sechan thinks that long-term growth will be there, due to more fiscal discipline, improvements in transparency and liquidity, rising per capita GDP and incomes, and a shift toward consumption-led growth versus export-oriented growth.
Another plus for Sechan is that emerging markets are now trading at the widest discount to developed markets since the financial crisis. "Even though we're slightly cautious in the very near term, if investors have a long-term time horizon, now is the time to start thinking about building up those [emerging markets] positions," Sechan says.
Cultivating a Global Perspective
For U.S. investors, emerging markets are a tough sell, Nuwayhid says. This is partly due to domestic investors spending their lives in a stable political system that has survived for 250 years, with a solid currency and an economy that, compared to the rest of the world, has shown remarkable longevity and soundness. Anything volatile or unstable seems like a bad bet, so the highest allocation to the emerging markets that Nuwayhid has reached with U.S.-based clients has been 20%, he says.
In contrast, Nuwayhid's international clients are mostly from the Middle East, a region where instability is the norm for currencies and economies. When Nuwayhid was three years old, every dollar was worth about three Lebanese lira; today, one dollar is worth about 1,500 lira. The political instability also affects investors there. "You tend to be significantly more reactive to news events and less trusting in the long term," Nuwayhid says of his Middle Eastern clients.
"When you take someone who resides overseas and recommend putting 25% or 30% or even as high as 50% in emerging markets equities and debt, they don't blink," Nuwayhid says. "That's what they've been doing their whole life. With a U.S.-based investor, you struggle to get to 15%."
Morningstar recommends that international equities should comprise 15% to 25% in a diversified stock and bond portfolio, with 7% to 12% in emerging markets. However, in light of what they believe are the undeniable long-term growth prospects, some advisors are committed to above average allocations in emerging markets. They have developed some intriguing ways to open their client's minds to expanding their emerging markets exposure.
When Dennis J. Stanek, Jr., an RBC Wealth Management financial advisor, talks to clients about investment opportunities in the emerging markets, he uses a map. The map has a circle around areas where Stanek sees opportunity, including sub-Saharan Africa, northern Africa, Singapore or Vietnam. At the top of the map is a quote from former professional hockey player Wayne Gretzky that reads, "I skate to where the puck is going to be, not where it has been."
It's a message that Stanek hopes to get across to his clients, who include high net worth families, endowments and foundations across the country. "Where the puck is going to be ... is the emerging economies," says Stanek, who is based in Hartford, Conn., with his team, the Stanek Blanchard Investment Group.
Stanek started adding clients' capital to the emerging markets just after the 2008 meltdown, when the asset class was down 35% to 45%. "I was happy to hope for a rebound and buy some growth assets at low P/E multiples. It came down to valuation and timing." That strategy has proved to be "absolutely" successful, Stanek says today, citing single to double digit returns off those 2008 lows.
That's why Stanek stays committed to keeping his clients in emerging markets. "I'm getting amped up," he says. "I've lightened up on U.S. equities, and I'm going to start putting the money into emerging markets equities today, adding to or building new positions."
DeMoss uses his conversations with clients to help them realize how the emerging markets have already influenced their lifestyles. That includes the Samsung televisions and the LG washer and dryer sets they buy, products which come from South Korean countries. "They use these countries' products, so why not invest that way?" DeMoss asks.
Emerging Market Portfolios
Convincing clients to embrace emerging markets is one thing. Structuring a portfolio that capitalizes on the promise of the asset class without undue volatility is another.
DeMoss's team favors emerging markets debt because its standard deviation is about a third lower than U.S. stocks and typically comes with a 5.5% yield over six years. To access those markets, DeMoss and his team turn to mutual funds that access non-BRIC countries, such as Malaysia.
To explain the investments to clients, DeMoss emphasizes the longer-term income horizon he is looking to create over five to seven years. Those investments, he tells clients, will mean the potential to make more money, but will also mean taking on more risks and volatility. He compares the process to putting clients' money into a time capsule that will not be open again for seven years.
"We're always trying to train people's thinking," DeMoss says. "You're trying to get them in the right markets, but at the least amount of risk they can stomach so that they can stay in it."
Stanek says that when clients first walk in the door, they have portfolios that are 50% to 60% in equities, with 5% to 7% devoted to international equities. Stanek and his team then apply an "institutional type model" to rearrange those investmentsstriving for as much as 40% in fixed income and 40% in equities, including a 20% allocation to international equities. The team turns to outside asset managers to gain exposure to the emerging markets, including separately managed accounts and mutual funds, and does not invest in emerging markets fixed income.
"There's got to be some entrepreneurs out there internationally. There's another Steve Jobs somewhere, maybe in India, Indonesia or Nigeria," Stanek says. "We'd rather invest there than put money into a government that will fritter it away."
Rebecca B. Hall, managing director of RBH Global Wealth Partners, an Ameriprise advisory practice with offices in Reston, Va., and Washington, D.C., tells her clients that having anywhere from 15% to as much as 35% international exposure in their portfolios, both on the equity and fixed income sides, can reduce the volatility in their portfolio. Hall, unlike many advisors, doesn't have to make the hard pitch for emerging markets40% of her clients are international, mostly employees of the World Bank and International Monetary Fund. Their familiarity with emerging and frontier markets means she'll often get calls from clients seeking investments in countries where they are citizens or already doing business.
Hall's clients can have as much as 15% exposure to emerging markets equities in their portfolio depending on their risk tolerance. All of her clients devote at least 5% of their equities to emerging markets. In addition, Hall's clients can have up to 10% exposure to emerging markets debt in their portfolios. The emerging markets equities exposure can come from ETFs, including funds devoted to developing or frontier markets, as well as managed portfolios. For the fixed income side, Hall uses funds that focus on areas like sovereign debt. For more conservative clients, Hall turns to American funds that are active in European and Asian Pacific regions or including large multinational companies that are actively doing business in developing markets.
To get U.S.-based investors to understand the emerging markets, Nuwayhid leads those conversations by emphasizing consumer and domestic demand themes. He also points to U.S. firms that are selling into the emerging markets. He increases client exposure gradually and then talks them through why he's doing it and what specific theme he's using, he says.
Nuwayhid's go-to investments include exchange-traded funds with a specific focus on the emerging markets consumer and domestic demand. He is also investing in emerging markets debt through ETFs and other funds. To get the "purest exposure," Nuwayhid prefers to invest in companies that are both based in the emerging markets and sell to the emerging markets consumer. If clients aren't comfortable investing in the emerging markets directly, Nuwayhid taps multinational firms that will benefit from emerging markets growth, even though they are not based there. "You may have clients with a very high U.S. bias who are not willing to venture into emerging markets," Nuwayhid says. "This is a good way to give them exposure."
When meeting with U.S. clients, Nuwayhid highlights their emerging markets investments and how well they have performed. While the emerging markets index was down 10.8% this year, some of his clients' investments are just down 1% and others are up. "I always point those out," he says. Over time, Nuwayhid thinks his clients have gotten more comfortable with letting him recommend increasing exposures in times like these, when valuations are attractive. "I'm showing clients we're getting similar characteristics to those of U.S. equities," he says.