Savant Investment Group | Market Matters for January 11, 2013
Below is a weekly update from our Chief Investment Officer, Dr. Scott Lummer. He co-hosts a seven minute audio segment entitled “Market Matters.” In this week's show, Scott discusses emerging markets, and why investors should consider investing in them despite their higher volatility. We also learn more about the host of the segment, Daphne O’Neal. Also, beginning this week, we are posting written transcripts of each episode along with the audio file (see below). Each week he covers a different piece of investment news focusing on recent events in the capital markets, and relates them to Savant Investment Group’s perspective on investing.
Listen to the Audio
Daphne: My name is Daphne O’Neal, and welcome to Market Matters. This week, we are going to talk about emerging markets. As always, we will talk about this with the Chief Investment Officer for the Savant Investment Group, Dr. Scott Lummer. Dr. Lummer, how are you today?
Scott: I am doing great, Daphne. Before getting started with investment analysis, I have received several questions from our regular listeners about … you. Many noted that a couple of months ago, we changed the format of the broadcast, and you became our host. Let’s talk a bit about your background. Besides asking great questions, you have many fascinating experiences, starting with your education. Please tell our listeners where you studied in college.
Daphne: I graduated from Harvard University.
Scott: And that explains why the questions you ask are much better than the answers I give. Now I know you have hosted radio and video segments in many fields, but you have specific experience in writing articles in financial publications.
Daphne: Yes, I have written about personal finance in as Zacks.com, Motley Fool, SFGate, the NYSE, TheNest.com, the Houston Chronicle.
Scott: It’s great that you have a lot of familiarity with investments and finance. So now I will turn it over to you. It’s actually much harder to ask questions than to answer them.
Daphne: Last week, in your year-end review, you mentioned that emerging markets were the best performing equity investment group for 2012. Is that often the case?
Scott: Over the long-term we would expect emerging market equities to be the best performing group of investments. They are also the most volatile group of stocks. That means on a year to year basis, they will frequently be the best performing asset class, as they were last year and in 2009. We would also expect them to be them to frequently be the worst performing asset class, as they were in 2011.
Daphne: What precisely are emerging market stocks?
Scott: They are stocks of companies domiciled in countries that are classified as an emerging economy, instead of being a fully developed economy. Often that definition is trapped somewhat by legacy. In the 1970s, when markets were first classified by economists as developed and emerging, the world looked different than it does today. Much of the world was still under communist rule – obviously a country had to have a free flowing capital market in order to be considered developed, regardless of the size of the economy. Those definitions of what is considered developed and emerging for the most part haven’t changed much since the 1970s.
Daphne: What countries are considered emerging that probably shouldn’t be?
Scott: Let’s start with China. A country that is the 2nd largest economy, and is projected by most economists to eventually to overtake the U.S. in terms of size, probably isn’t truly emerging. When I was there in 1987, there were oxen carts in the main streets of Beijing. That’s no longer the case. Add to that the other so called BRIC or B R I C countries – Brazil, which is the 6th largest economy, India, which is 9th, and Russia, which is 10th.
Daphne: Why haven’t those four countries been reclassified?
Scott: Probably because, outside of size, those four economies have much more in common with other emerging markets than they do with developed markets. For example, China’s economy grew last year at a 9% rate, India at a 7% level, and Russia at a 4% rate. The average emerging market grew at a 5% rate, whereas the average developed market grew at 1% level.
Daphne: Is that higher growth rate the reason investors should be interested in emerging markets?
Scott: That is certainly the main reason – and it’s related to the higher expected long-term returns from investing in those stocks. The other reason is diversification – an emerging stock portfolio is likely to help diversify an U.S. investor’s risk more than a developed stock portfolio.
Daphne: Why is diversification better for emerging market stocks?
Scott: Let’s look at some specifics. I looked at a few international developed market mutual funds – typical holdings included stocks like Samsung, Bayer, Nestle’, British American Tobacco. I would venture to say that many listeners were not even aware that Bayer and Nestle’ were not U.S. companies. On the other hand, a typical emerging market fund has companies such as Baido, the Chinese equivalent of Google, and America Movil, a South American cell phone service provider. If I am asking which companies offer true diversification benefits, meaning, they are likely to go up when U.S. stocks go down, my money is on Baido and America Movil, instead of the developed market stocks.
Daphne: Would you suggest investors not use any developed market stocks and only emerging market stocks?
Scott: No. Both offer some advantages. And remember, emerging market stocks are far more volatile than develop markets stocks or U.S. stocks. But, whereas developed market non-U.S. stocks only make up about ¼ of the market value of all non-U.S. stocks, we suggest that investors should put about half of their international equities in emerging markets. Investing more than that could add too much volatility to the entire portfolio.
Daphne: Thank you Dr. Lummer, and this concludes this week’s Market Matters broadcast.