Building wealth from emerging markets

Sydney, Tuesday, 17 November - The long-term outlook for emerging economies will impact positively on emerging market investments according to Watson Wyatt, but it warns that choice of asset class and implementation route are not obvious. In a new research paper entitled Emerging Wealth, the firm suggests that emerging market equities, debt and currencies are where exposure to the macroeconomic dynamics of emerging markets will be most readily obtained.

Jeffrey Chee, investment consultant at Watson Wyatt in Australia, said: “We believe that emerging market economies will continue to grow strongly, due to a mix of rising productivity, economic and financial reforms, and favourable demographics. However, institutional investors face significant complexity and potentially high fees when trying to build a portfolio that captures this long-term trend and should also recognise the governance implication of following such a strategy.”

In the paper, the firm outlines its rationale for expecting strong future economic growth in emerging markets. These include:

• The ongoing shift in focus from agriculture to industry and services
• Favourable demographics (growth in the labour force, particularly relative to developed markets)
• Globalisation, in particular the integration of China and India into global trade will significantly increase the supply of inexpensive labour
• An increasingly conducive environment for foreign direct investment
• Deepening capital markets, high rates of investment and the adoption of technology to improve efficiency
• Trade with other emerging economies becoming increasingly important.

Jeffrey Chee said: “By way of contrast, a number of developed markets where funds have significant equity exposures exhibit significant current account deficits, such as in the US, and unfavourable demographics due to an ageing population, such as in Japan and Europe. These factors, coupled with a large public and private sector debt overhang, may lead to a weaker economic outlook in the near term as households and governments seek to de-leverage and save more.”

According to the paper, emerging economies need to meet a number of conditions if high, long-term growth is to be achieved. These include stable monetary and fiscal objectives and inflation-targeting as well as the provision of education to provide a flow of skilled workers to meet increasing demand as an economy grows. In addition, the adoption of new technology as a key driver of improvements in capital efficiency and a robust legal system based on the rule of law make economies with democratic governments more likely to achieve strong future economic growth.

Jeffrey Chee said: “We believe that the starting point for gaining exposure to emerging economies should be via asset classes that are correlated to the macro trends, are liquid, have higher capacity and have relatively low transactions costs and manager fees. As such, we believe that investing in emerging economies should start with equities, debt and currency.”

According to the firm emerging market equities should be an important part of an institutional fund’s allocation because economies experiencing high economic growth and high returns on physical capital can deliver relative outperformance. The case for investing in emerging market debt rests on the long-term improvement in the economic fundamentals of emerging countries which should lead to improved credit quality, lower yields on emerging market bonds, appreciation of emerging market currencies and improved liquidity of emerging market debt. It recommends that investors should have exposure to a long-term dynamic basket of emerging market currencies, funded in a diverse basket of G4 currencies: Yen, US dollars, Euro, Sterling. This would provide direct long-term exposure to higher relative productivity growth in emerging countries and world rebalancing themes.

The paper includes some of the key issues of other potentially attractive asset classes, including:

• Real estate is reasonably correlated with GDP growth, however markets are highly heterogeneous, with some markets relatively immature
• Many private equity managers have skills that position them well to generate returns by helping portfolio businesses develop and grow. The firm has a preference for growth capital over buyouts
• There is a strong case for high levels of spending by emerging countries on new infrastructure projects. However, we believe that there will be a wide range of outcomes for foreign, private providers of capital. Some investors may choose to access infrastructure through the indirect exposure of developed and local market equities and others will seek, and benefit from, more direct forms of investment.

For more information on Australia contact

Sonja Lee
National Marketing Manager
Watson Wyatt Australia
Telephone:+61 2 9253 3176
sonja.lee@watsonwyatt.com.au

Ex-Australia

Paul Deane-Williams
Head of Public Relations - Investment and Insurance & Financial Services
Watson Wyatt Limited
+44 (0)1737 274397
paul.deane-williams@watsonwyatt.com

About Watson Wyatt Investment Consulting

Watson Wyatt Investment Consulting, a division of Watson Wyatt, is focused on creating financial value for institutional investors through independent, best-in-class investment advice. We are specialist investment professionals who provide co-ordinated investment strategy advice based on expertise in risk assessment, strategic asset allocation, and investment manager selection. Watson Wyatt Investment Consulting provides investment advice to some of the world’s largest pension funds and institutional investors, and has over 550 associates in Europe, the Americas and Asia.

In Australia, Watson Wyatt is the leading investment consultant to institutional investors, and advises clients with assets of over $200 billion. It has offices in Sydney and Melbourne.

In the US investment advisory and investment consulting services are provided by Watson Wyatt Investment Consulting, Inc., which is a subsidiary of Watson Wyatt Worldwide Inc. Watson Wyatt Investment Consulting, Inc., is a registered investment adviser with the Securities and Exchange Commission.

Watson Wyatt (NYSE, NASDAQ: WW) is the trusted business partner to the world’s leading organisations on people and financial issues. The firm’s global services include: managing the cost and effectiveness of employee benefit programs; developing attraction, retention and reward strategies; advising pension plan sponsors and other institutions on optimal investment strategies; providing strategic and financial advice to insurance and financial services companies; and delivering related technology, outsourcing and data services. Watson Wyatt has 7,500 associates in 33 countries and is located on the Web at www.watsonwyatt.com.