Emerging Markets Equity and Commodities – Remind me again, why?
The portfolio role of emerging markets equity and commoditiesOften, it can help to start at the beginning. Why did these asset classes make it into the portfolio to begin with? The primary driver for adding diversifiers to a portfolio of U.S. stocks and bonds is typically because they have historically performed differently from U.S. stocks and bonds. As we have just experienced, both emerging markets and commodities check that box. Beyond the different performance pattern, each has a separate primary role to play.
- Emerging markets are typically included in a portfolio to increase the overall return potential of the portfolio. Based on Russell Investments’ Capital Market Projections, emerging markets equities have the highest long-term return expectation on a 20-year time frame. This is based on a number of factors, but higher Russell-projected long-term economic growth from these markets is a significant factor.
- Commodities are included primarily for their historically unique return pattern from stocks and bonds, and thus their potential volatility-lowering impact on the overall portfolio. According to our Capital Market Projections, commodities are expected to deliver long-term returns between stocks and bonds, varying based on conditions.
Should investor expect improvement in the future?The short answer is “likely,” but patience will be necessary. History has shown that following difficult (negative) stretches, these two asset classes tend to rebound with solid to strong numbers. Emerging Markets represented by the Russell Emerging Markets Index. Commodities represented by the Bloomberg Commodity Index. Of course, investors need to bear in mind that both asset classes are likely to deliver high levels of volatility for the foreseeable future, as global growth remains choppy and oil prices try to find a bottom. However, long-term, current attractive valuations for emerging markets equities, and low energy prices suggest these two assets classes may have room to move up in price over time, rewarding patient diversified investors with appropriate risk tolerance levels.
The bottom lineIt can be very difficult to stick with an investment that “hasn’t been working.” Unfortunately, disappointing results from the past five years would suggest that emerging markets equity and commodities fit that category. However, before abandoning any investment it’s best to revisit the original reason for holding it and assess its potential future impact on the portfolio. In the case of emerging markets and commodities, we believe that both have the potential to deliver on long-term objectives for investors with commensurate risk tolerance. Emerging markets are still positioned to potentially deliver among the highest returns in a diversified portfolio and commodities are likely to continue to deliver a unique return pattern relative to stocks and bonds.
1 Represented by the Russell 3000® Index
2 Represented by the Bloomberg Aggregate Bond Index
3 Represented by Russell Developed ex-U.S. Large Cap Index
4 Represented by FTSE EPRA/NAREIT Developed Real Estate Index
5 Represented by S&P Global Infrastructure Index
6 Represented by Bloomberg Global High Yield Index