Matthew PeronChief Investment Officer, Senior Managing Director | 2018

Emerging Market Equity Positioning

The “free lunch” of naïve diversification is over, and the most important decision an investor can make when constructing a globally equity portfolio is where to invest regionally.

ATTRACTIVE LONG-TERM VALUATIONS

We see compelling long-term valuation opportunities in this asset class at a time when many countries have improved their economic standing and companies are making meaningful, positive changes to their operating models. Despite offering a significant growth premium and improving fundamentals, Emerging Asia equity markets still trade at a long-term historical 25-30% discount to those in developed markets.

Over time, rising global weightings should also continue to push funds into Asia. Although the contribution of EM to global growth continues to increase, the asset class remains vastly underrepresented in global indices in relation to its economic significance. Emerging Markets currently account for just 17% of total global market capitalization, a number we expect to change profoundly between now and 2030. As underlying economies mature, capital markets deepen and domestic savings pools become institutionalized, the proportionate share of EM equity is predicted to account for up to 40% of a global asset pool that is projected to grow from $80 trillion today to $515 trillion.

Changes in regulation vary significantly from country to country, but the trend has been toward higher international participation. Relaxation of borrowing market rules in some EM Asia countries should contribute to increased liquidity in local equity markets. The introduction and rapid growth of readily available, efficient financial instruments and vehicles has also contributed to the democratization of investing in these markets, thus enabling investors to better express their convictions.

DIVERSIFICATION BENEFITS

Exposure to Emerging Asia equities not only offer investors in developed nations the potential of higher returns, but also risk reduction benefits through portfolio diversification. The rising degree of global financial market integration has prompted some to question whether EM can still provide meaningful diversification in portfolios. It’s true that a renewed bout of global risk aversion would likely pose headwinds for EM, which continues to trade with a heightened beta to global markets. Emerging Markets are, after all, part of the global economy and thus not immune to the impact of global shocks from both fundamental and technical perspectives. Still, our analysis indicates that significant diversification benefits, from Asian markets specifically, have persisted in the long term, making a strategic allocation to EM Asia equities an effective diversifier for clients from DM risk.

CONCLUSION

The “free lunch” of naïve diversification is over, and the most important decision an investor can make when constructing a globally equity portfolio is where to invest regionally. Not all economies and markets are created equal, and opportunities (and risks) across the globe are growing increasingly divergent. However, client goals of higher returns and diversification are still possible with a targeted, intelligent approach to global equity investing.

In a world largely starved for structural growth, we believe that Asian equities and credits represent some of the best long-term values we see across global capital markets. Profound structural changes are redefining long-term investment opportunities in Emerging Asia. The convergence of demographics, innovative technology, and government reform is leading to stronger and more resilient domestic economies in which a dynamic private sector is playing an increasingly significant competitive role.

Asia’s surging middle class, coupled with strong productivity trends, signal robust structural growth for the foreseeable future. Having the two key components of GDP—labor force growth and productivity—trending so strongly is an important differentiator for the Asian region at a time when many parts of the global economy are facing demographic and/or productivity challenges. Compelling urbanization patterns across the region are helping, too. As a result, overall GDP per capita in Asia is growing significantly faster than in many other parts of the world.

From an investment standpoint, we think that these drivers of strong structural growth across a variety of industries, including technology, consumer and financial services, education, and health care delivery, will be constructive for the trajectory of Emerging Asia equity earnings and multiples in the coming years. There are current risks associated with our positive outlook, but our base view is that over time the investment profile of EM is compelling enough to overcome short-term gyrations that could be caused over such recent concerns above excess debt in China, currency devaluations, and slowing global trade. As such, we continue to recommend a long-term strategic overweight to Asian equities for investors looking to capture enhanced return and diversification benefits.

The “free lunch” of naïve diversification is over, and the most important decision an investor can make when constructing a globally equity portfolio is where to invest regionally.

Sources and Disclosures

Sources for 4P Data

BCA Research

Bloomberg

Bureau of Labor and Statistics

CEIC Data

CIA World Factbook

Cornell University

FactSet

Global Innovation Index

Goldman Sachs

Heritage Foundation

Insead

International Monetary Fund

Ned Davis Research

OECD

SC Johnson College of Business

St. Louis Federal Reserve

tradingeconomics.com

WIPO

World Bank



Important Disclosures

City National Bank provides investment management services through its wholly owned subsidiary City National Rochdale, LLC, a registered investment advisor.

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell, any of the securities mentioned herein.

Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources, and, although believed to be reliable, it has not been independently verified, and its accuracy or completeness cannot be guaranteed.

Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change.

As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money. Returns include the reinvestment of interest and dividends. Investing involves risk, including the loss of principal. Diversification may not protect against market loss or risk.

Past performance is no guarantee of future performance.

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