Remember when you were a kid? Summer life was fairly simple. Life happened day-to-day. When you wanted something, it was rather immediate – not in a week let alone a year or longer. I think that every parent has said, “Be patient child.” I know I have!
I remember my parents telling me, “patience is a virtue.” It is easy to see in a restless teenager this lack of wisdom. Easy to say, but sometimes hard to practice. However, as we grow older the good news is many find it becomes easier as we realize our intrinsic biases.
In previous blogs, we have written about emotions and investing and how our emotions can derail our intended efforts. To read more about being your worst enemy, click here. Patience plays a very important role in investing in general – letting the time value of money take root and grow into larger amounts of capital – but patience is so important in more volatile asset classes. One of these is the emerging markets.
Over the past 15 years, I bet many of you reading would be surprised, the Emerging Markets has been the best performing broad asset class returning 12.7% annually. Yep, better than small caps, large caps, and others. (1) Some might be saying, “I haven’t seen that.” Well, we are going to explore potential reasons.
We had a chance to sit down and discuss the emerging markets and better understand some of investment nuances with Leon Eidelman the portfolio manager of JP Morgan’s Emerging Market Equity fund. If I were to summarize Leon’s over all message, it would be to have patience – especially with investing in emerging markets.
To understand why, we need to look at the dynamics of emerging market returns. There are four key facets associated with emerging markets which dictate returns – earnings growth, dividends, currency fluctuations, and valuations. One’s return, is the summation of the contribution of each of these.
If we look at how each of these contributors of returns vs the length of time invested over a longer period of time, for example past 5 years, we can see the impact of each and why length of investing time is so important. The graphic below shows the percentage contribution to total returns by holding horizon. (2)
In the example above, which looked at the past 5 years, there was 8.3% annualized growth in the Emerging Markets as proxied by the MSCI EM Index. As we discussed above, earning growth accounted for 10.2% of the return – the lion’s share. Dividends were accretive adding 2.6%. Currency subtracted from performance as the US Dollar strengthened about 36% over the past 5 and a half years is next. (4)
In the early months, valuations drive the return the majority of returns. You would expect this, as the equities haven’t had time to grow earnings. The second component of returns in these early months, and unlike equities who receive their revenues in US Dollars, is currency fluctuations. This component is unique to emerging market equities, and frankly foreign equities as a whole. Over the last 40 years, there have been 5 major changes in the strengthening and weakening of the US dollar ranging +/-14% to 55%, with each of these increases averaging about 9 years. In times of a strengthening US Dollar a negative impact to emerging market/foreign returns, and vice-versa.
As you increase your holding time frame, earnings are what matter. If you stop and think about the dynamics here, it become very apparent that as companies grow their earnings, they become more valuable. Additionally, the influence of dividends starts to take hold and increase. More to come on this phenomenon in another blog.
This is why patience is so important in long-term financial success. One must allow the time necessary to permit the compounding of earnings growth, and dividends be reflective in market pricing. This is one of the cornerstones in our investment philosophy.
We profess that no one can tell you what is going to happen in any market in the short run. Believing you can time the markets is a fool’s-errand. Markets go up and they go down. Currencies fluctuate in cycles based on many factors but in the long-run, have a smaller impact on overall performance. If you choose shorter time frames, what you pay (valuations) will drive returns – both positively and negatively. In the long run, secular themes shape returns. For more information on investing in business cycles, read our blog here.
Although this example uses the emerging markets as its discussion subject, we believe the lessons can be universally applied. Seeking quality equities at below historical valuations, the belief that earnings growth are the critical component of capital appreciation, the importance of increasing dividends are 3 of the cornerstones of our investment philosophy.
If you find yourself agreeing with this philosophy and want to learn more on how this approach might benefit you, give us a call and we can talk about your specific situation.
If you are a client and have questions, calls us and we will walk through every position you own and explain how it adheres to these principles.
Sources & Disclosures
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
All indices are unmanaged and may not be invested into directly. The MSCI EM Index is a capitalization weighted index of emerging market stocks designed to measure performance of the broad emerging market economy.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.
International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
All investing involves risk including loss of principal. No strategy, including rebalancing and diversification, assures success or protects against loss.
The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time.
Past performance is not necessarily a reliable indicator for current and future performance.
- JP Morgan Guide to the Markets Page 60. Data as of 5-31-2018
- JP Morgan Asset Management prepared for this writing. The chart as of March 2017 based on data from MSCI Emerging Markets for the period between 1994 and 2017. Past performance is not necessarily a reliable indicator for current and future performance. This chart breaks down the four sources of return when investing in the stock market. It is highlighting the importance of focusing on earnings growth ( as opposed to valuations) as that is what is the largest contributor to returns over the longer term.
- JP Morgan Guide to the Markets Page 45. Data as of 5-31-2018
- JP Morgan Guide to the Markets Page 45. Data as of 5-31-2018