A new academic paper examines cross-country differences in the diversification benefits that emerging markets offer, and why Latin America may be the best deal for foreign investors.
(December 2, 2012) -- Emerging markets allow investors to achieve lower risk, higher returns, and expanded risk/return possibilities, especially during periods when developed world investors need diversification the most, a newly released academic paper asserts.
The research -- compiled by C. Mitchell Conover of the University of Richmond, Gerald R. Jensen at Northern Illinois University, and Robert R. Johnson of Creighton University -- concludes that the emerging markets are valuable to the developed market investor during periods of heightened inflationary concerns. "Latin American markets are particularly impressive as a diversifier during restrictive monetary environments," the authors pointed out.
According to the research, the superior investment benefits offered by the Latin American index may be attributed to the relatively heavy reliance Latin American companies place on the export of commodities.
Describing the research's methodology, the paper continues: "To evaluate the implications that emerging markets have for portfolio performance, we generated alternative efficient frontiers from the equity indices. In general, we found that emerging markets allow investors to achieve lower risk and vastly expanded risk–return possibilities than what is available from developed market portfolios."
The region with the largest allocation in these efficient frontiers was Latin America. "Finally, we confirmed that when developed market investors need diversification the most (when US inflationary concerns are elevated) is precisely when the benefits of investing in emerging markets, and especially Latin America, are the greatest."
Another surprising fact highlighted by the authors: the contribution of currency risk is surprisingly low in emerging markets. "For the period studied, the contribution of currency risk was less than 1% in 15 of 20 emerging countries; it was lower for the equally weighted and GDP-weighted emerging market indices than when measured for the developed market EAFEC (Europe/Australasia/Far East plus Canada) and MSCI indices," the paper said.
Read the entire paper here.
Latin America's growing influence in the emerging world among fund managers is reflected in a May 2011 report, which showed that assets in Latin American pension and mutual funds will reach $1.4 trillion over the next five years, with Chile becoming the most attractive market. The report -- titled Institutional Asset Management in Latin America -- revealed that private pension fund managers in Chile have benefited from heightened regulation championing diversification and urging greater investment in equities and overseas investments. "Chile has the most liberal investment policy for portfolio managers of its pensions, due to the small size of its capital markets with increasing amounts permitted to invest internationally," Ciampi said.