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China’s zero COVID-19 policy is having an impact on its economy, along with a collateral effect on other nations.STR/AFP/Getty Images

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With North American stock indexes still hovering around record highs, many investors are looking for opportunities in markets that are not valued so highly. That search may include emerging markets.

However, Russia’s invasion of Ukraine, the resurgence of COVID-19 in China, and a possible debt default in Sri Lanka have reminded investors of the risks in less developed international markets.

So, how should advisors be thinking about emerging markets at this time? Is it a great opportunity, or a reason for caution?

We asked some Canadian strategists, fund managers and investment advisors whether investing in emerging markets makes sense right now. Their responses showed divergent opinions on whether to allocate funds in these areas – and how to do it.

Gavin Graham, chief strategy officer at SmartBe Investments Inc. in Kelowna, B.C., is among those who are bullish on emerging markets.

“Now is a good time to be investing in emerging markets as they have underperformed developed markets for most of the past decade,” he says.

He notes this is largely due to the high exposure to commodities for many of these countries – an area that has shown little price appreciation until very recently.

“Now, commodities are in a bull market, which has only been reinforced by the sanctions on Russia and the disruption to Ukraine’s exports. We should see a rise in both their markets and currencies,” Mr. Graham says.

When it comes to specific countries, he says Asian nations that have been taking market share from China such as Vietnam, Indonesia, the Philippines, and Bangladesh look attractive.

“Sub-Saharan Africa is also interesting with countries like Ghana, Kenya, and Nigeria worthy of consideration while Colombia, Chile and Peru in South America [in South America] have relatively good value and well-developed markets,” he says.

But not all market watchers are as positive on investing in underdeveloped international areas right now.

“We are still underweight emerging markets at this time,” says Sadiq Adatia, chief investment officer at BMO Global Asset Management in Mississauga.

The first reason for caution he points to is China’s zero COVID-19 policy, the resulting impact on its economy, and the collateral effect on other nations. Mr. Adatia also says China’s moves to regulate and pressure its technology companies seem to be easing, but there’s no assurance that will continue.

Turning to the Russia-Ukraine situation, Mr. Adatia notes that sanctions against Russia and the countries that support it could continue to grow, and companies could continue to pull out of those regions, adding more pressure to their economies.

Another negative Mr. Adatia mentions is that in the short-term food inflation will be much higher and impact consumers in emerging markets – reducing their spending on other parts of their economies.

Diversification, higher risk, and picks

However, many advisors point to a classic reason for Canadians to invest in emerging markets.

“In my opinion, emerging markets belong in a portfolio to improve overall diversification,” says Andrew Pyle, portfolio manager and senior investment advisor with The Pyle Group at CIBC Wood Gundy in Peterborough, Ont.

Mr. Pyle says some investors shy away from emerging markets because of the perception that these stocks will be more volatile than Canadian stocks. But he cites statistics that, over the past 20 years, the long-term average for 30-day volatility for the MSCI Emerging Markets Index is only about 16 per cent compared to about 14 per cent for the benchmark S&P TSX Composite Index.

But, there are additional risks in investing in individual emerging market companies, such as currency fluctuations. He says investors should try to minimize this impact by using either an exchange-traded fund (ETF) or mutual fund that offers some form of hedging back to Canadian dollars.

Mr. Pyle also notes that an active approach should be used to invest in emerging markets as opposed to simply buying a passive fund, mainly because having an equal weighting to China, the largest economy in the emerging markets index, can introduce risks.

Mr. Pyle likes Mackenzie Maximum Diversification Emerging Markets Index ETF MEE-T, which doesn’t have the same exposure to China as the benchmark index, nor does it have the same exposure to the two main segments of the passive index – financials and technology.

Some other advisors are more cautious.

“My advice to a Canadian investor would be that emerging market investments would be higher risk as you are investing in markets or countries that are not [developed],” says Allan Small, senior investment advisor with Allan Small Financial Group at iA Private Wealth Inc. in Toronto.

He notes volatility can be quite high at times and investors have to be able to handle possible losses.

“This type of investment is not for everyone and usually makes up a small portion of a diversified portfolio,” he says.

Mr. Small adds it can be very difficult and pricey to buy a stock trading on a stock exchange outside of North America, so he tries to stick with names that can be bought in Canada or the U.S.

“The U.S. exchanges have [several] companies whose shares you can purchase that may be domiciled in an emerging market or country,” he says. “I believe it’s better buying a stock that trades in New York versus trying to buy stock on foreign exchanges, which cost a lot more to trade.”

While buying foreign American depositary receipts is one option, Mr. Small favours buying well-established large-cap companies that are domiciled in North America but do business in emerging markets.

This approach gives investors “the best of both worlds,” he says.

“They can buy the stock easily with no added cost or headache – and they’re getting a well-established company headquartered in the U.S. or Canada but because they do business all over the world and will benefit if that emerging market does well,” Mr. Small says.

He says Starbucks Corp. SBUX-Q, Micron Technology Inc. MU-Q and Qualcomm Inc. QCOM-Q are ways to gain exposure to China. Caterpillar Inc. CAT-N is a play on the emerging market infrastructure buildout, while Bank of Nova Scotia BNS-T gives exposure to Central America, South America and the Caribbean.

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