"...emerging markets will grow faster than the
developed world for decades to come."

Gideon Rachman, The Financial Times

Market timing in emerging markets

Market timing in emerging markets

Big gains and big losses make distant markets a challenge, but strategy may actually work in this case. Investors are repeatedly told not to engage in market timing, but the strategy may work in emerging markets, which are subject to dramatic variations in performance.

An analysis of emerging market performance for the 10-year period ended Dec. 31, 2002, using the MSCI emerging markets free, MSCI EMF Asia and MSCI EMF Latin America indices — in Canadian-dollar terms — indicates that investors who are patient are more likely to make smaller gains or lose money in emerging marets.

Over the 10 years, the MSCI EMF index was up 3.56%, MSCI EMF Asia was down 0.42% and the MSCI Latin America index was up 6.03%. Investors would have lost money in each index over the one-, three- and five-year periods ended Dec. 31, 2002, because each index was in negative territory in the periods.

But investors could have made significant gains if they’d used a market timing strategy in emerging markets during the period.

The maximum calendar year gain on the MSCI EMF index was 82.3% in 1993, and the minimum gain was the maximum loss of 28.2% in 2000. In Asia, the maximum gain was 108.3% in 1993 and the minimum was a loss of 45.9% in 1997, while the maximum and minimum in Latin America were 60.5% in 1996 and a loss of 30.4% in 1998, respectively. The mean returns for the each of the three indices over the 10-year period were 7.8% (MSCI EMF), 7.1% (EMF Asia) and 10.1% (EMF Latin America).

Comparatively, investors in the S&P 500 composite index would have made 11.76% in C$s over the 10-year period, 1.4% over five years and lost money over the one- and three-year periods. The S&P 500 also provided relatively more stable returns, with a maximum return of 39.2% in 1997, a minimum of a loss of 22.9% in 2002 and a mean return of 13.59%.

A better understanding of the variation in emerging maret performance is provided by the returns’ standard deviation, which quantifies the extent of the variation. The smaller the standard deviation, the lower the variance in returns from the mean return.
The standard deviation of returns over the 10-year period in the EMF Asia was the highest at 45.8, followed by the EMF index at 34.8 and EMF Latin America at 31.7. The S&P 500 had a standard deviation of 20.85.

Evidently, the wide variation in returns provides investors with the opportunity to take gains in years of stellar performance and avoid losses during dramatic declines.

“Emerging markets either dramatically outperform or underperform over various time periods,” says Craig Millar, international equity analyst at Altamira Investment Services Inc. in Toronto. “While market timing is difficult, significant gains can be made by getting out at the right time.”

The variations in emerging market performance are influenced by a host of systemic and non-systemic risks. Over the period under review, the 1994-95 Mexican crisis, the 1997 Asian crisis, the 1998 Russian crisis and the 2000 global stock market crisis have all had varying degrees of influence on market performance. And political, economic and regulatory risks associated with individual countries that make up a particular index can also affect performance, as well as cash inflows and outflows.

“One has to look at the systemic risks associated with each country,” says Chuck Wong, portfolio manager of Dynamic Far East Fund and StrategicDundee Emerging Market Fund for Dynamic Mutual Funds Ltd. in Toronto. The risks cannot be “diversified away but they can be avoided.”

Picking winners in emerging markets is also made difficult by varying accounting and financial reporting standards that make comparisons unreliable. In developed markets, it is more likely that the prices of securities are a true representation of their underlying value. This leads to a lower probability of correction and lower overall volatility. “My advice is not to time the market,” says Wong. “It is prudent to be patient on the expectation that stock prices always climb higher over the long term.”

How do investors make money in emerging marets if they are not market-timers? Stock selection, not country selection, is key, says Millar, who, like Wong, is a bottom-up manager. But this strategy can suffer from the dominant “market effect” in emerging markets — meaning it is difficult to diversify away the unique risk of securities within a portfolio.


Dwarka Lakhan

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.

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