Emerging markets (EM) are growing in prominence as engines of global growth and political and cultural influence. Underpinned by sustained economic development and increasing openness to foreign investment, the breadth, depth and maturity of EM capital markets have increased tremendously over time.
Nonetheless, many perceived risks remain that are unique to EMs and have hindered larger strategic allocations, including concerns about political risks, macroeconomic contagion and corporate governance. As a result, EM allocations are often small and tactical as investors bet on cyclical upswings and flows. However, as global interest rates have declined to secular lows and developed market (DM) assets offer muted expected returns due to elevated valuations, investors are compelled to broaden their investment universe to meet return and diversification objectives. In this regard, EMs may be a key part of the solution to the dilemma investors are facing today.
Departing from the familiar realm of traditional EM benchmarks, GIC and PIMCO propose a portfolio construction framework comprised of two key building blocks:
- A risk-based anchoring portfolio with balanced risk budgets across asset classes and regions; and
- A valuation-aware overlay reflecting expected return signals (based on value and carry, for example).
The original paper was published in the Journal of Portfolio Management (JPM) and is republished here with permission from JPM. Access the full report here.