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Emerging market shares have out-performed developed market shares since January 2016. The chart below shows emerging market shares (blue) have returned well over 50% (in AUD) since January 2016. This is approximately double the return of developed market shares (red) over the same period.

EM vs DM

You might be thinking: “I wish I’d invested more in emerging markets back in early 2016.” Its easy to look back in hindsight and think about what might have been. It’s much more helpful to have a framework that makes apples with apples comparisons across asset classes.

For example, here’s a simple framework that my friends at Heuristic Investment Systems and I use to compare asset classes. Our framework considers a range of variables, which we group into four main categories:

  • Value – How does the price of an asset compare to a) history and b) other assets?
  • Policy and Liquidity – Is government and central bank’s policy easy or tight?
  • Macroeconomic Change – Is economic activity accelerating or slowing down?
  • Momentum – Has recent performance been up or down?

All other things being equal, cheaper valuations result in higher long-term returns. That said, valuation is useless when it comes to short-to-medium-term forecasting. That’s why it’s important to consider the situation holistically. This is exactly what our simple framework is designed to do.

The actions of governments and central banks have a powerful effect on the economy and asset prices. Corporate revenues and profits improve when the economy is doing well.  Both of these effects can be particularly strong over the medium-term.

Performance tends to persist in the short-term. In other words, winners keep winning and losers keep losing. This pattern reverses over the medium-to-long-term as winners (losers) become expensive (cheap) and valuation becomes more important.

The four indicators all work over different time horizons. Longer-term investors should pay more attention to value. Short-term investors should pay more attention to price momentum. Consequently, investors should weigh the importance that they give each indicator according to their investment horizon.

Here’s how emerging market shares looked back in March 2016 using our asset allocation framework. The scores are a standardized composite of 3-4 different measures. The bars indicate the historical maximum and minimum for each measure. The boxes indicate the range of scores that mark a significant deviation from the long-term average. This is shown by the dotted line in the box.

31 March 2016

Emerging markets were very cheap. Not at their all-time cheapest, but significantly cheap.  Policy and liquidity were neutral. Economic momentum was positive. Price momentum was neutral.

Investors with a medium-to-long-term investment horizon should have been attracted to emerging market shares. Long-term returns (i.e. cheap valuations) were better than those of other asset classes and the other factors were all positive or neutral.

Here’s how emerging market shares scored twelve months later at the end of March 2017. The increase in price saw valuations normalize. That said, emerging market shares were still cheap. That is, they were trading at a discount to developed market shares.

31 March 2017

There’s literally something for investors focusing on all investment horizons in this chart. Emerging markets are cheap, monetary conditions are supportive, economic growth is accelerating and price momentum is strong. The upward trajectory of emerging market returns (blue line on first chart) really started to accelerate at this time.

The final chart shows emerging markets in mid-April 2018.

11 of April 2018

Value is now neutral. Strong performance over the last two years means that emerging markets are now trading in line with historical valuations. That said, they remain cheap relative to developed markets. Policy and liquidity remain accommodative.

Macroeconomic growth has slowed. This is due to a deterioration in forward earnings growth expectations. There are lots of potential reasons for this. For example, it could be that rolling 12-month comparisons are now tougher to beat after the strong earnings growth in recent months. Price momentum turned negative in January 2018.

How should you interpret this framework? The answer depends on your investment horizon, circumstances and objectives. It’s quite possible and completely OK, for two investors to look at this chart and arrive at different conclusions.

A significant portion of my retirement savings are invested in emerging market shares. I’m reasonably confident that the returns to emerging markets will exceed those of developed markets over the long-term. I repeat, long-term. I have no idea what emerging markets will do in the short-term. That’s why I use a framework to monitor my investments and to make adjustments as new information becomes available.


Few things in investing are either black or white, which is why it’s important to use a framework to help you make better investment decisions.

Asset allocators should consider a range of indicators as part of a systematic and disciplined investment process.

The indicators and the importance assigned to them should match the investor’s time horizon.

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