Fidelity International is encouraging investors to become more involved in developing countries despite the ongoing unrest in the Middle East and North Africa and the hint of a banking crisis in Korea, which are sure to foment further market volatility.

With an apparent reversal of fortunes between emerging and developed markets having come to pass post-financial crisis, and most UK investors’ allocation to emerging market assets already at low levels (3.5 per cent), Fidelity is urging investors not to forget the diversification benefits of investing globally.

Since October, emerging markets have underperformed developed markets by more than 10 per cent and are lagging over 12 months.  Fidelity argues, however, that investors need to look at what impact a home bias could have on their portfolios.  Recent research carried out by Fidelity looking at total UK investor assets (including bonds) shows that investor allocations have not kept pace with the growth of investable assets in emerging markets and global markets.

With UK investors’ aggregate allocation to emerging market assets at just 3.5 per cent, as of September 2010 - up from 1 per cent in 2000 - it still is more than 10 percentage points lower than the current 13.6 per cent share of emerging market equities in the MSCI AC World Index.  On the other hand, UK investors’ aggregate exposure to their home assets market was a sizeable 49.8 per cent in September 2010, more than 40 percentage points above the share of UK equities in the MSCI AC World Index, Fidelity notes.  Based from these numbers, Fidelity is reminding that investors persisting in a home bias in their asset allocation are likely to suffer from inferior risk-adjusted returns as a result.

Tom Stevenson, investment director at Fidelity International, argues that there are plenty of reasons for the recent reversal towards developed markets, none of which supports an end to the long-term case for emerging markets.

“However, undoubtedly one of the most important secular themes of our age is the ongoing shift in economic power away from developed countries to leading emerging markets such as China and India,” he said. 

“This current long-term power shift is underpinned by a host of supportive factors in emerging markets, including strong growth, rising incomes, favourable demographics, and enhanced macro-stability.”

According to Stevenson, underweighting emerging markets can be a costly mistake and he suggests that those who remain convinced of the long-term investment case for emerging markets use this period of underperformance as a tactical buying opportunity.

According to Fidelity, there are three key points investors should consider when thinking about their allocation to emerging markets: new year rotation, earnings revisions and improving relative valuations.  The firm further reminds investors that not all emerging markets are the same.

“As emerging markets’ share of global GDP and global equity market capitalisation continues to rise, it seems inevitable that they will see more investment inflows from developed markets.  In light of this, investors should be evaluating their portfolios to consider the existence of any unwarranted home biases and whether a higher allocation to faster-growing global and emerging market assets might be necessary,” concludes Stevenson.