Emerging Markets for the Long Haul: The Small-Cap Opportunity
Written by the KAR Emerging Market Investment Team
Emerging market equity was one of the most volatile asset classes in 2018 as headwinds such as tariff concerns, a rising U.S. dollar, and political uncertainty contributed to severe losses. Despite these challenges, the case for EM remains strong.
Long-term investors should know that volatile and sometimes outsized swings in performance are quite the norm when it comes to emerging markets, and that the asset class—particularly the small-cap segment— can be a long-term winner and an important component of a well-diversified portfolio, thanks to its improving fundamentals and potential for outperformance.
Emerging market (EM) stocks posted impressive absolute and relative performance in 2017, with the MSCI Emerging Markets Small Cap Index gaining 33.84% and the MSCI Emerging Markets Large Cap Index up 37.70%—versus 25.03% by developed market stocks (MSCI EAFE® Index), 21.83% by U.S. large-cap stocks (S&P 500® Index), and 14.65% by U.S. small-cap stocks (Russell 2000® Index). Not long after, however, EM stocks about-faced, with the EM small-cap index falling 18.59% and the EM large-cap index falling 14.85% in 2018.
The decline in EM stocks throughout 2018 was the result of a combination of factors that played out globally, namely global liquidity and tightening monetary policy by the world’s central banks, the strengthening U.S. dollar, country-specific risks, such as the economic slowdowns in Turkey and Argentina, and trade tariff friction with China.
Despite various near-term challenges, the long-term case for emerging markets remains intact.