The Investment Scientist

Posts Tagged ‘emerging markets

ImageIt really caught me by surprise when Eugene Fama, the newly minted Nobel laureate in Economics said: “It doesn’t matter that much.” when speaking about investing outside of the US.

OK sure, I can understand his point. Why invest outside of the US when the US markets already account of 40% of world capitalization? “The U.S. market is so well-diversified already that combining it with global markets doesn’t really matter,” so said Fama.

However, I think it actually does matter ….

Proportionally, the US market is getting smaller. Right after the second world war, the US market accounted for 70% of world capitalization, now it only accounts for 40%. For a country that boasts only 5% of of the world’s population, this is still exceptionally high.

For the foreseeable future, there are better than even odds that the combined markets outside of the US will grow faster than the US market will do alone. Why forego those opportunities?

The diversification benefit you’d get is certainly not negligible either. During the so-called ‘lost decade’ of 2000 to 2009, the US market, as measured by the S&P 500, had a net loss of 9.1%, while international developed markets went up by an anemic 12.4%, but emerging markets went up by a whopping 154.3%.

It would have made a bog difference if you have a piece of emerging markets in your portfolio.

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Last year, while the S&P 500 was largely flat, small cap value and emerging markets were down significantly. No wonder some clients of mine got a bit edgy.

What a change one month has made! As of Feb. 5, these two asset classes have roared back with a vengeance. See the table below.

2012 Year to Feb 5th 2011
DFA US Small Cap Value 12.74% -9.74%
DFA Emerging Mkts Value 19.44% -26.50%
DFA Intl Small Cap Value 12.74% -19.41%

The lesson here: when we see big losses like -19%, -26%, we can view them as a financial Armageddon or as a buying opportunity. The latter position is mentally much harder to take, but it almost always pays off. 

Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.

Recently I asked my assistant John to pull up Harvard Endowment’s 13F filing for Q4 of 2010 and compare it to that for Q4 of 2009 (shown in table below).

Apparently, Harvard Endowment’s year-end position in 2010 had changed significantly from that of 2009. The way I see it, there are three significant changes:

1. At the end of 2009, Harvard Endowment was extremely bullish on emerging markets; the top 10 positions were emerging market positions. That number was reduced to 5 at the end of 2010. On top of that, the size of each emerging market position has been reduced. Take China for example; the value of shares of FXI was reduced from 365k to 203k.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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