Not financial advice. Full disclaimer available here.
Do you remember the chart below?
It shows expected real returns for a select group of Emerging-Market (EM) equities over the next 10 years. This same chart was featured in the thesis on EM financial exchanges, except it’s updated as of Oct. 31, 2022.
What’s missing from the chart is the probability of actually achieving those returns. That probability is 50% (the mean of distribution). In other words, EM equities have a 50% chance of yielding a return above 9.2% and a 50% chance of yielding a return below 9.2%. That’s useful to know but, as investors, maybe we want better odds.
What are the levels of return associated with a probability of 75%?
The returns are lower compared to chart 1 because lower returns have a higher probability of being eclipsed (6.1% < 9.2% since 75% > 50%).
Brazil is still in first place followed by Malaysia which moved up one spot. Poland fell off the podium behind China which has improved EM’s ranking as a whole due to its large weighting in the MSCI index. Mexico ranks #6 again while Thailand beats Indonesia by 0.2%. As a group, developed markets remain unattractive relative to EM, mostly because of the US weighting.
Here is how to read India’s negative 1.6% score:
The Indian stock market has a 75% chance of yielding a real return above -1.6%
Or, the Indian stock market has a 25% chance of yielding a real return below -1.6%
The next chart shows the most probable range of outcomes:
Brazil stands out. According to Research Affiliates, Brazilian equities have a 50% probability of returning between 13% and 24.8%. The low end of the range is 4.5% and the top end of the range is 33.3%. The candlesticks capture 90% of probable outcomes and the mid point is the mean of distribution, 18.9% for Brazil as shown in chart 1. See footnotes for the exact percentages for each market.1
Again, EM looks more attractive than DM and India does not look good. For other markets, the comparison is more nuanced.
Poland has the second highest potential in terms of yielding a high rate of return. However, the probability of losing money in Poland is higher than in Malaysia. Mexico’s return profile is less attractive than China’s. Indonesia has a wider range of outcomes than Thailand but they are very similar.
All the above is hypothetical in nature and no model is perfect. But Research Affiliates’ asset allocation tool is as good as it gets, more than $140bn in assets are managed worldwide using investment strategies developed by RA.
The long-term expected returns for core emerging markets can be used as a benchmark to assess the merit of any stock idea, including in developed markets. Remember, the current base case is a 9.2% return per annum for the next 10 years. Of those 9.2%:
3.6% come from dividend yield
3.8% come from earnings per share growth
1.8% come from valuation change, including 1.1% from asset and 0.7% from FX
Here are the current dividend yields for a select group of EM financial exchanges: 8% for GPW (Poland), 6% for Bolsa (Mexico), 3.8% for SGX (ASEAN).2
For Ashmore, the yield is 8% and their AUM are invested as follows: 39% in Latin America, 29% in Asia Pacific, 20% in the Middle East and Africa, and 12% in Eastern Europe.
RA disclaimer: expected returns as shown in chart 1 are not intended as point estimates but instead represent the mean of a distribution. Viewing this distribution from a left cumulative perspective shows the probability of achieving different levels of real return. Lower returns have a higher probability of being eclipsed, and higher returns have a lower probability.
The legend below explains how chart 3 was put together based on the table above.
Brazil is not part of the EM financial exchanges thesis because B3 is not available to most investors. “One China” is not investable in my view.
Related cashtags: EPOL 0.00%↑ ; EWZ 0.00%↑ ; EWM 0.00%↑ ; EWW 0.00%↑ ; EEM 0.00%↑ ; EIDO 0.00%↑ ; THD 0.00%↑ ; MCHI 0.00%↑ ; INDA 0.00%↑