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Does it still make sense to invest in emerging markets? Well, yes, investors have to put their money somewhere. And if you make the right selections, EM stocks or bonds can often outperform assets in developed markets. But the consistently big returns that emerging markets used to offer may be a thing of the past.
For many years, from the late 1980s, stocks in the benchmark MSCI Emerging Market Index outperformed developed world stocks by a wide margin. But for most of the past decade, EM stocks have moved sideways while US stocks for example, have more than doubled in value.
Investment in emerging markets was driven by one big idea - that their economies would inevitably converge with the developed world. But that no longer looks so sure. By far, the biggest and fastest growing EMs are China and India. But if you set them aside, the rest of the emerging world in terms of per capita GDP has been growing more slowly than the developed world since 2015.
So what has changed? Well, for many years, EM growth was driven by globalisation, cross-border trade, global supply chains, and the commodity supercycle. But commodity prices have been falling for almost a decade, supply chains are being disrupted, and trade is slowing. Globalisation risks going into reverse.
China has grown so quickly because it's invested much more than other countries. But for EMs as a whole, investment is falling behind. Last year, foreign direct investment to emerging markets was at its lowest level since the 1990s.
EMs may yet regain their growth advantage. Things like demographics and urbanisation may work in their favour. But for that to happen, governments will have to enact difficult structural reforms, which many abandoned during the boom years. Without reform, it's hard to see how emerging markets will regain their growth momentum. The past 20 or 30 years may well have been an anomaly.
