Why Value Investing Is Making a Comeback in Emerging Markets

Emerging markets have historically been a prime market for growth-oriented investors. After all, these economies are known for their rapid gross domestic product (GDP) growth compared to developed countries in Europe or the United States. As growth slows around the globe, as it did in 2019 and 2020, it could create a chance for value investors to invest overseas.

Here's a look at why value investors may want to look at emerging markets, as well as some methods for getting involved.

Benefits of Value Investing

Value investing has become more popular in both developed and emerging markets. A large and growing body of evidence suggests that investing in stocks with below-average price-earnings or price-book ratios, or above-average dividend yields, provides better returns over the long run. Successful investors such as Warren Buffett have capitalized on this to earn above-market returns over time.

A paper published in Emerging Markets Review in 2002 showed that these tendencies carry over into emerging markets, with value stocks generating higher returns than non-value stocks. A subsequent Credit Suisse report found that value stocks outperformed in all but three of 21 emerging markets between 2000 and 2013, with the average value premium being 4.3% per year compared to just 3.1% in developed countries.

The risk profile of value stocks may also be attractive to many investors, including those who want to invest in emerging markets. By buying shares at a discount, there is presumably less potential downside than with a high-flying stock with few assets or earnings. There is also evidence that value stocks are less volatile than high-growth stocks, which means that investors are assuming less risk in terms of beta.

Value Investing in Emerging Markets

Emerging markets saw a big downturn during the Great Recession in 2008. This got worse when the U.S. Federal Reserve stated that it would scale back its quantitative easing (QE) program and raise interest rates. Many emerging market currencies saw a large decline in value. That makes it costlier to repay dollar-denominated debt, which is used by many emerging market governments and companies to borrow. This type of debt reached $4 trillion in 2020.

The big decline in crude oil prices made these problems worse since many emerging markets aren't as diverse as developed economies. Developing economies are often concentrated in fewer product categories than the developed world. When one of those products is oil, the economies are hit harder by price drops. Crude oil accounts for a large portion of economic output for countries such as Russia and Venezuela, as well as most of the countries in the Middle East.

These forces have led to large capital outflows from emerging markets, which has depressed their valuations relative to developed markets. For example, the iShares Core S&P 500 ETF (IVV), which closely tracks the S&P 500, traded at a 25.55x earnings multiple on January 7, 2021, whereas iShare's ETF tracking the MSCI Emerging Markets Index (EEM) traded with a price-earnings ratio of just 18.30x. Value investors may find emerging markets have more opportunities than developed markets.

ETFs, Mutual Funds, and Stocks

There are many ways that you can invest in emerging markets, including through stocks, ETFs, or mutual funds.

International ETFs are the easiest and most cost-effective way to build exposure. This is because they provide an entire portfolio within a single security. Plus, they often have lower expenses than comparable mutual funds. While there are many emerging market ETFs to choose from, only a handful of them focuses on value investing. Most of these are so-called smart beta funds, which use alternative indexing strategies.

The most popular emerging market value ETFs include:

• FlexShares Morningstar Emerging Markets Factor Tilt (TLTE)
• iShares MSCI Emerging Markets Minimum Volatility (EEMV)
• SPDR S&P Emerging Markets Dividend (EDIV)
• WisdomTree Emerging Markets High Dividend (DEM)

There may be more mutual funds to choose from that focus on emerging market stocks. But most of these are actively managed, rather than passive funds. Their expense ratios may also be a great deal more costly than ETFs. That means that you should think about whether the manager’s track record and other factors are worth the higher fees.

Some popular emerging market value mutual funds include:

• T. Rowe Price Emerging Markets Discovery Stock Fund (PRIJX)
• Brandes Emerging Markets Value Fund (BEMIX)

Finally, investors can purchase individuals stocks as American Depositary Receipts (ADR) trading on U.S. exchanges, or as foreign stocks trading on exchanges abroad. Often, the easiest way to find these stocks is to use a stock screener like FinViz. Look for foreign stocks trading at discounted multiples or high-dividend yields. The downsides to this method are that it may be more pricy to build a portfolio, and many of these stocks are less liquid.

The Bottom Line

Emerging markets have long been growth investor targets, but their recent downturn has created a chance for value investors, too. When looking at stocks and funds, you may want to seek out value-orientated funds or screen for individual stocks. Still, keep in mind the impact of higher costs, liquidity, and other risk factors.

Frequently Asked Questions (FAQs)