Emerging Markets: Reshaping the Investment Landscape

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1 Emerging Markets: The case for increased asset allocation to emerging markets Excel Investment Counsel Inc. June 2015

2 Emerging markets are reshaping the investment landscape Demographics are shifting. Emerging markets ( EM ) are growing faster than developed markets ( DM ) The seismic shift in the global economy, engendered by the dramatic rise of emerging markets, is expected to permanently change the way Canadians invest. As the magnitude of the shift continues to accelerate over the next three decades, the relative importance of emerging markets as an asset class will increase exponentially, opening new windows of opportunity for investors to enhance their risk-adjusted returns by investing in the world s fastest growing economies. This shift will necessitate the re-orientation of asset allocation models to allow for greater exposure to emerging markets, which will account for an ever increasing percentage of global investable assets. The genesis of the shift Since they were first identified in 1981 as countries transitioning from developing to developed economies, the number of emerging markets has grown steadily, allowing emerging markets to become an increasingly important component of global equity portfolio allocation. In 1988, for instance, when Morgan Stanley Capital International (MSCI), a leading global index provider, launched the first comprehensive emerging markets index, it listed 10 countries in the MSCI Emerging Markets Index. Today, the MSCI Emerging Markets Index covers securities across 23 markets. As emerging markets grew in size and numbers, they endured numerous economic and political shocks. Among the shocks were the 1994 Brazilian real and Mexican tequila crises, the 1997 Asian currency crisis, the 1998 Russian ruble crisis and the 1999 Argentine peso crisis. Each of these shocks triggered varying degrees of volatility in the global financial markets, highlighting the risks of investing in emerging markets. Over the past decade, however, emerging market governments have learned from their past mistakes and put their houses in order. As a result, since 2000 these emerging markets have become fundamentally stronger than their developed counterparts and have been able to recover from shocks in a manner similar to developed markets. Their strong internal fundamentals, combined with significant improvements in their monetary, fiscal, and governance policies have put emerging markets on a firmer footing, giving them the ability to withstand future shocks. In fact, following the worst economic crisis in modern day history during the period, emerging markets emerged stronger than ever, leading the global economy out of its slump, while developed markets struggled to recover. 1

3 The Global S-Curve U.S.A. 75,0000 Switzerland Australia Canada Japan Germany Germany France U.S.A. Luxembourg Korea, Rep. Logarithmic Scale 10,0000 1,0000 China Mexico Indonesia India Russia Thailand Brazil Chile Emerging Market Countries Developed Market Countries Zimbabwe Afghanistan Ethiopia FronRer Market Countries Malawi For Illustrative Purposes Only In spite of their growing collective strength, it is important to note that the universe of emerging markets represents a diverse set of countries with different characteristics and varying opportunities. Therefore, all emerging markets should not be painted with the same brush when making investment decisions. The fundamental strengths of EM The evidence of stronger emerging market fundamentals is indisputable, accentuating the case for increased allocation to these markets. Here are some of the main reasons why emerging markets are reshaping the investment landscape. Emerging markets are already growing faster than developed markets and will continue to do so for decades to come Higher emerging market foreign reserves will reduce emerging market dependency on developed markets, therefore allowing them to withstand future currency shocks Emerging markets have outperformed developed markets over the long-term The younger demographic in the emerging markets, combined with their growing middle classes, will fuel increased domestic consumption and infrastructure development, thereby accelerating economic growth The investment universe of emerging markets will soon approach the size of developed markets Higher developed market debt continue to stifle developed market growth while lower emerging market debt benefits emerging market growth 2

4 The Growth is in EM Emerging economies, on average, are forecast to grow more than twice as fast as their developed counterparts in the first half of this century. Comparatively, the growth of developed economies will be flat during the same period, highlighting the fact that emerging markets will offer more opportunities for investors. As the chart to the right demonstrates, the average gross domestic product (GDP) growth of emerging markets to 2050 will be approximately 5.0%, compared to 2.0% for their developed counterparts. EM estimated to grow 2 to 3 times as fast as DM Region/ Country Average World 3.9% 3.3% 3.4% Developed Markets Emerging Markets 2.1% 1.9% 2.0% 7.1% 5.1% 5.0% Canada 1.9% 1.8% 1.9% U.S.A. 2.8% 2.2% 2.4% Estimated Average growth (%) DM 2.0% EM 5.0% Brazil 3.2% 4.1% 3.8% China 8.4% 4.7% 4.6% India 9.6% 7.5% 7.5% Indonesia 8.5% 6.7% 6.6% Mexico 4.9% 5.2% 4.8% Russia 2.5% 3.4% 3.3% Turkey 4.9% 5.3% 4.8% Source: Pricewaterhouse Cooper: World in 2050, February, In fact, in 2014, 70% of the world s growth is forecasted to come from emerging markets, led by countries such as China and India. Comparatively, Canada is expected to contribute only 1% to the global GDP growth. EM forecasted to be the majority of world growth INDIA Growth in emerging markets is expected to be fuelled by increasing domestic consumption led by a growing middle class, foreign direct investment, and increasing exports. CHINA Other EM Source: International Monetary Fund: World Economic Outlook, April,

5 The investment universe of EM will surpass that of DM The market capitalization of emerging markets has expanded exponentially since 2000 and is expected to surpass developed markets over the next two decades. In 2000, the total market capitalization of emerging markets was a mere USD $2 trillion dollars, compared to developed markets which accounted for USD $29 trillion. 14 years later in 2010, the market capitalization of emerging markets had grown to more than 8 times, to USD $17 trillion. By 2030, the capitalization of emerging markets is forecast to reach USD $124 trillion, almost 3 times the markets cap of the developed markets in EM equity asset class growing faster than DM DM EM % CAGR 7.8% CAGR 77% 38% 7% 18.0% CAGR 12.3% CAGR EM % is relative size to DM It is further projected that by 2030, emerging markets, including those of the developed Asian countries, are expected to account for almost 45% of total global market capitalization, making the traditional developed markets less important when it comes to investing globally. And the number of opportunities keeps growing, fuelled by the advent of newer emerging markets. by 2030 EM expected to account for 45% Global markets capitalization Source: Credit Suisse: EM in 2030; Goldman Sach: Global Economics Paper No: 2041 as at May 25, We estimate the aggregate global capital markets opportunities in 2014 at US $153 trillion, rising to US $515 trillon by Credit Suisse Research Institute Emerging capital markets: The road to 2030 July

6 Higher DM debt will stifle DM growth, while lower EM debt will benefit EM growth The government debt-to-gdp ratio of developed countries is on average greater than 110%, compared to about 42% for emerging markets. Various studies show that high debt is an impediment on the economies of developed countries and a significant deterrant to economic growth. EM Goverments Less Leveraged than DM Goverments Source CIA World Factbook 2014 Estimate. Coincidentally, the debt-to-gdp ratios of emerging markets have fallen dramatically since the turn of the century, providinig emerging market policymakers with greater flexibility to implement fiscal and monetary policies. At the same time, the risk premium of emerging markets debt has declined dramatically with the debt ratings of many emerging markets such as China, Russia, Brazil and Mexico being upgraded to investment grade. Developed Markets Sovereign Debt Ratings Country January 2000 April US AAA AA+ France AAA AA Italy AA BBB- Japan AAA AA- Spain AA+ BBB Emerging Markets Sovereign Debt Ratings Country January 2000 April China BBB AA- India BBB BBB- Russia CCC BBB- Brazil BB- BBB+ Mexico BBB+ A Philippines BBB+ BBB South Africa BBB+ BBB+ Colombia BBB+ BBB+ South Korea A AA- Turkey NA BBB Indonesia B- BB+ Debt Ratings Source: Standard & Poors ratings for local currency debt, Bloomberg, April 30,

7 Higher EM foreign reserves will reduce EM dependency on DM and allow them to withstand currency shocks The emerging markets currently account for approximately 70% of the total reserves (including gold and US dollars) held by all the countries tracked by the World Bank data. EM Hold Majority of Global Foreign Reserves High foreign reserves provides the governments with the ability to stabilize exchange rates and provide a more favourable economic environment to purchase its domestic currency and to protect the country from attacks by speculators. High foreign reserves are also an important indicator of a country s ability to repay their foreign debt and are a factor in determining a country s overall credit rating. Source: Bloomberg as at May 15, EM have outperformed DM over the long-term In spite of their greater volatility, emerging markets have significantly outperformed developed markets over the 15 year period ending April 30, During this period, the MSCI Emerging Markets Index produced a total return of 179% compared to only 54% for the MSCI World Index. With emerging markets set to perform well going forward, there is scope for long-term investors to make superior risk-adjusted returns in emerging markets. MSCI World Index MSCI EM Index 54% Total Return (%) in CAD Bloomberg, April 30, 2000 to April April 30, % Conclusion The center of gravity of global investing has shifted from developed markets to emerging markets. Emerging markets are expected to remain fundamentally stronger than their developed counterparts in the foreseeable future. Their share of total global market capitalization is expected to increase steadily and eventually surpass developed markets in size by As a result, Canadian investors should consider increasing their asset allocation to emerging markets to assist in enhancing their risk-adjusted returns. 6

8 Excel Group of Funds BLUE CHIP FUNDS EXCEL BLUE CHIP EQUITY FUND EXCEL BLUE CHIP BALANCED FUND EMERGING MARKET EQUITY FUNDS EXCEL INDIA FUND EXCEL CHINA FUND EXCEL CHINDIA FUND EXCEL EMERGING EUROPE FUND EXCEL LATIN AMERICA FUND EXCEL BRIC FUND EXCEL EMERGING MARKETS FUND FIXED INCOME FUNDS EXCEL HIGH INCOME FUND EXCEL MONEY MARKET FUND CLOSED END FUNDS EXCEL INDIA GROWTH & INCOME FUND EXCEL LATIN AMERICA BOND FUND EXCEL LATIN AMERICA BOND FUND II For more information on how Excel Funds can help you invest wisely in Emerging Markets call or visit excelfunds.com. About Excel Funds Established in 1998, Excel Funds Management Inc. is a pioneer in emerging markets investing in Canada, and now offers the widest selection of emerging market funds to Canadian investors. Excel Funds is Canada s only mutual fund company that is solely focused on investing in emerging markets. Through its network of subadvisors, Excel Funds gives its investors access to the knowledge base and expertise of over 200 local portfolio managers and analysts around the world. Excel Funds on-the ground sub-advisors, proprietary asset allocation model and best-in-class portfolio managers contribute to the firm being recognized as Your Authority in Emerging Markets in Canada. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the simplified prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. This document may make forward-looking statements and there are risks that actual results could differ materially from forecasts, projections or conclusions in the forwardlooking statements. Certain material factors and assumptions were applied in drawing the conclusions or making the forecasts or projections in the forward-looking statements and you may find additional information about such material factors and assumptions and the material factors that could cause actual results to so differ from the sources provided. The information contained in this document is for informational and illustrative purposes only and is not intended to provide specific financial, investment, or other advice to you, and should not be acted or relied upon in that regard without seeking the advice of a professional. Particular investments or trading strategies should be evaluated relative to each individual. 7

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