What role can emerging markets play in U.S. investors’ asset allocations?

The emerging markets asset class can serve two useful roles in a long-term investor’s portfolio:

• Emerging markets offer a prospective source of diversified growth within a long-term investor’s portfolio. During much of the last 15 years, the concept of decoupling was in vogue for the emerging market asset class, but was overstated and misapplied. However, Seafarer believes that two recent structural changes – reduced reliance on exports and independent monetary policy – might finally allow the markets to decouple from the developed world. Decoupling is now relevant, for the first time.
• A high-quality, income-producing portfolio of emerging market securities (dividend-paying stocks and bonds) can act as a useful source of diversification (or hedge) against the U.S. dollar. Seafarer believes that long-term investors should seek exposure to productive assets with meaningful growth potential, and that are capable of generating income in currencies other than the U.S. dollar.

How should long-term investors integrate the emerging markets asset class into their portfolios?

The emerging markets are likely to remain volatile for the foreseeable future. Risk appetite must dominate any consideration of the asset class. Seafarer believes that investors should consider two key factors:

• Long-term time horizons are essential. Given the volatility of the asset class, due especially to heightened currency risk, Seafarer suggests that investors adopt a minimum investment horizon of five years.
• Investors should manage U.S. dollar versus non-U.S. dollar exposures in their portfolios. Rather than initially allocating capital among traditional “asset classes” (e.g., domestic stocks, foreign stocks, bonds, real estate), Seafarer believes investors should measure the portion of their assets that are principally denominated in U.S. dollars versus those assets that are not. After matching U.S. dollar assets against U.S. dollar liabilities, a portion of the surplus capital (e.g., 10% to 30%) can be allocated to the emerging markets.

What should investors consider when investing in China?

Seafarer continues to invest selectively in China, acutely aware of the challenges and risks. In a Letter to Shareholders, Nicholas Borst reports that Seafarer has consistently advocated for a balanced approach to the risks of investing in China. Seafarer’s investment team has sounded the alarm on risks in the Chinese market, including stimulus-driven asset bubbles, an overleveraged property market, the impact of a deteriorating U.S.-China relationship, and the Communist Party’s efforts to exert control over Chinese companies. As the market has finally caught up to the reality on the ground, it has been accompanied by volatile moves in the prices of Chinese securities.

Nicholas states that while there are many challenges to investing in China, there are also reasons to be optimistic, including a growing number of Chinese companies with opportunities to expand outside of China’s domestic market. Seafarer will continue to “seek truth through facts” when investing in China, developing a deep understanding of companies through thorough analysis of their earnings, balance sheets, and governance structures.

In a Prevailing Winds blog post, Security Over Growth: China’s New Economic Approach, Nicholas Borst explains how Chinese economic policy has been reoriented in the Xi Jinping Era. While China has not officially turned its back on the policies that drove rapid economic growth, Chinese policymakers are increasingly prioritizing national security concerns over economic ones. Investors’ understanding of how the Chinese economy works must be updated accordingly.

Can new business models create economic efficiencies in the developing world?

In the commentary Brazil’s Fintech Revolution, Kate Jaquet describes how financial services companies in Brazil are upending the country’s banking system with new technologies and business processes, serving consumers in new ways, and offering millions of Brazilians their first bank accounts. Brazil may offer a partial roadmap to the future of financial innovations in the emerging markets – particularly noteworthy are the substantial strides in making the financial system more competitive, more digital, and more inclusive.