By Steven Podnos, MD, CFP
Learn more about Steven on NerdWallet’s Ask An Advisor
Your well-diversified portfolio may not be what you think it is.
Chances are it doesn’t contain enough investments in emerging markets — generally those places with low to middle per capita income outside of developed countries like the U.S., Canada, Japan and many countries in Europe. This is because global diversification has traditionally only meant including among your investments some stocks from large, developed countries beyond our borders.
This may not be good enough anymore. The global economy is undergoing a major transformation, and you may need to alter your allocation if you want your portfolio to keep up.
Major wealth shift
Driven by globalization, urbanization, advances in technology and aging populations, the world is seeing an accelerating shift in wealth from west to east, according to Richard Dobbs and James Manyika in their fascinating 2015 book, “No Ordinary Disruption: The Four Global Forces Breaking All the Trends.” The world’s center of economic gravity — a rough measure based on each country’s wealth and location — is moving east toward China and other emerging markets faster than ever before, the economic researchers argue.
They point to various economic data highlighting this incredible shift. For instance, the increase in productivity in China in recent years has occurred at a pace 10 times the speed and 300 times of the magnitude of England’s productivity during the Industrial Revolution in the 19th century, the authors say. In 2013, China accounted for 60% of all new global economic activity and is now the world’s largest manufacturer. As investors around the world catch on, the share of global investments in emerging markets including China has risen from 34% in 2007 to 60% in 2013.
A growing number of people moving to cities is part of what’s driving this increase in economic power and wealth. By 2025, 46 of the world’s top 200 cities, based on projected gross domestic product, will be in China. Urbanization is also improving health and education at record speed. At the same time, the internet and technological advances allow the rapid sharing of knowledge around the world like never before. A classroom in a remote village can log on and access much of the same information for free online as Ivy League universities on the other side of the world.
What investors can do
These economic trends suggest that the emerging markets of the world will continue to be places where much wealth is created and that participating in their stock markets will be a wise long-term decision. Doing so has become relatively simple for everyday investors, as there are many mutual funds and exchange-traded funds that invest in emerging markets using both active and passive management strategies.
Investors should have a significant amount of their investments in emerging markets — but how much of any given portfolio depends on each investor’s situation. For instance, if I were a young investor with the ability to take on a fair amount of risk, emerging markets would make up half of my international investments. For older investors nearing retirement, it may make sense to reduce exposure to emerging markets.
We know that different regions tend to cycle up and down in performance year by year and that we have had several years of good performance mainly in domestic stocks. And while some analysts have said that investing in the U.S. Standard & Poor’s 500 index gives the investor an adequate exposure to global industry, it’s no longer clear that this holds true in a world in which the economic center is not in the West. Talk to your investment advisor about whether you have a piece of this rapidly changing world.
Ultimately, this incredible shift shows that we can’t know how much and what kind of change the future will bring. But for now, the signals are clear. Investors should pay attention to and invest in emerging markets if they want to benefit from their growth and the dramatic shift in wealth.