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Invest in global emerging markets

29 May 2006 Gary Noone, Invesco

Investment returns from South African stocks have been very impressive in recent years. Indeed, the FTSE/JSE All-Share index has risen by 275% (total returns) in US$ terms over the three year period to the end of April 2006 (source: Bloomberg).

By comparison, the MSCI Emerging Markets index registered a gain of 210%, with total returns from the MSCI World index lagging far behind at 80%. Stripping out the currency impact and pricing all the returns in the rand would not change these performance rankings.

Diversify?
This may leave some local investors questioning the need to diversify some of their hard-earned money into overseas markets, when returns generated from home are superior. Excluding the time when gold prices previously peaked in 1980, the recent strengthening of South African stocks has been unprecedented, thus leaving local stocks looking expensive. Investors still wishing to ride the wave of the commodities boom can do so by diversifying their portfolios into other emerging markets.

Why Global Emerging Markets?
Global Emerging Markets (GEMs) offer potentially superior economic growth prospects relative to developed markets. The dynamic and competitive nature of their economies together with an attractive population profile should ensure that their share of global GDP is likely to rise over the long term.

Valuations in many of the emerging countries still remain reasonable. Equities are trading at a 20% forward discount to the MSCI World index. Dividend yield is above 3% and dividend growth is being maintained.

GEMs are underdeveloped. The asset class constitutes only 7.5% of the worlds total market capitalisation of stocks, but contributes 23.6% of global GDP.

Economic policies
Economic policies have been prudent and consistent across the regions. This has generally resulted in current account surpluses, appreciating currencies and surging foreign exchange reserves. Improvements to the macroeconomic landscape have reduced market volatility levels as the ability to weather any economic downturn is now much stronger.

Global liquidity inflows remain extremely positive as the asset class becomes more mainstream, set against a benign global inflation environment.

Credit fundamentals have improved dramatically, resulting in several sovereign credit rating upgrades and IMF debts being paid off. About two-thirds of GEMs are now investment grade. Risk premiums have contracted.

Structural reforms
The introduction of structural reforms has greatly benefited the corporate sector. Balance sheets are stronger, shareholder returns have improved and there is enhanced corporate governance. Corporate profitability levels are also growing at a faster rate than many of the developed market companies.

Gary Noone, Invesco

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