Emerging market economies are continuing to play a lead role in global growth, contributing over 50 per cent of world GPD, but many investors are going about gaining exposure to these markets in the wrong way, according to Alan Conway, head of emerging market equities at Schroders.

Conway’s view is that many investors are relying too much on developed market companies to gain exposure to emerging markets. Many developed market firms are of course now generating a significant chunk of their revenues from emerging markets – from around 9 per cent in 1990 to almost 20 per cent today.

Conway believes that it is best to invest directly in emerging markets stocks rather than indirectly through developed market companies. He notes that not only does the indirect route dilute the investment, but investors may also pay a premium for developed companies’ operations in the rest of the world, as they will still be investing in companies with 50 per cent or more of their income from developed markets. 

The weakness of this approach is reflected in performance returns, Conway says. Goldman Sachs has produced a BRICs Nifty 50 Developed Markets Index which comprises 50 companies from the developed markets that are believed to directly benefit from strong growth in the emerging economies. The median exposure to emerging markets, as defined as a percentage of operating profit, is 29 per cent.  This index has significantly underperformed the MSCI Emerging Markets Index, he points out.

Of course, some investors prefer indirect investment into emerging markets in the belief that this approach eliminates the perceived higher risks of emerging markets. However, according to Conway, emerging markets might now represent the safer option in light of the parlous finances of many developed countries.

“We believe emerging economies today represent something of a safe haven, with low sovereign, corporate and household debt levels, high savings rates, large current account balances and huge foreign currency reserves. This is in contrast to the debt-laden developed world undergoing structural changes,” says Conway.

While direct investment may be preferable, Conway cautions that investors need to adopt a very careful approach: they need to have specialist knowledge of the political, macro-economic and currency factors which have a major influence on the performance of companies. “Moreover, regulations and governance, although improving, are not as comprehensive as in developed countries,” he says.