Investors in emerging markets have had it rough in recent years, but the outperformance of China and technology stocks could be a reason to hope.

Emerging markets stocks make up 12% of the global stock market. Thirty years ago, these stocks spoke to less than 1% of the world’s investable equity market capitalisation. These markets are active and have changed dramatically in the past three decades, with the pace of change only accelerating. What has compelled them and how will they evolve in the future?
The MSCI Emerging Markets Index was launched on January 1, 2001. From its inception to the end of 2017, the index posted yearly gains of 9.89%, versus 4.99% for its developed markets counterpart. Though these figures are persuasive, they mask the volatility that has characterised this 16-year time period.

Emerging Markets Bounce Back 2017

The years between 2010 and 2016 have been especially taxing for investors in emerging markets stocks, with indices falling over 1% on a yearly basis, versus a gain of over 8% for developed markets.
But after almost seven lean years, emerging markets equities have re-emerged in 2017. Emerging markets index increased 27.8%, while its developed markets counterpart rose 16% during 2017.
The success of a pair of Chinese tech giants, Tencent and Alibaba are an indication of the changing face of emerging markets; conversely, commodity and Brazilian stocks have struggled in recent years.
The tech-led stock rally is not a US marvel: emerging markets are participating, too. The transition from a portfolio dominated be basic materials and energy to one led be emerging giants of technology have marked the most recent evolution of emerging markets, but what might come next?

China Moves to Centre-Stage

MSCI’s decision to include China A-shares in the index is recognition of the significant steps China has made toward opening its capital markets to foreign investors in recent years. Exchange-traded funds and index funds tracking the affected indexes will add to some or all of the 222 A-shares allocated for inclusion to their portfolios.
It is a noteworthy first step toward greater integration of the domestic Chinese capital market and will bring China’s standing in equity indices more in line with the true footprint of the nation’s capital markets and its economy at large.

Diversification Benefits Dwindling

The level of correlation between developing and developed markets has increased significantly since 2001 and this means the benefits of investing in emerging markets to diversify has started to dwindle. As emerging markets start to integrate into the global economy, they will start to move in step with developed markets.

Investors should in future continue to expect a bumpy ride; these countries’ economic progress will be lumpy and their stock markets’ returns lumpier still.