Demand for EM equities rises

Home bias for most developed markets has been falling over the last decade.

If numbers are to be believed then the world is increasingly veering towards emerging markets (EMs) — both for profits and returns. For a long time foreign investors have retained their bias towards home markets (read developed markets) as these countries have accounted for a lion’s share of the world’s GDP.

But a lot of that is changing, at a much faster pace than investors can imagine. The burgeoning middle-class is driving demand in emerging economies such as India and China, and corporate and investors are chasing them alike.

According to reports, the 30 companies in Dow Jones Industrial Average generate nearly 43 per cent of their revenues from outside the United States, up from 39.6 per cent in 1996. Simultaneously, the share of EMs in global GDP has risen substantially from 20 per cent to over 30 per cent in a span of eight years (between 2002 and 2010).

John Prestbo, editor and executive director of Dow Jones Indexes, in his column pointed that the US market, while still the biggest, accounts for 42 per cent of the world’s total market value of stocks, down from 55 per cent in 2001-2002. “That means more investment opportunities exist outside US than within its borders.” Investors seem to be realising this the world over.

Consequently, home bias (preference for domestic equities) is falling rapidly in developed markets. But the market capitalisation of the MSCI EM is just over $4.1 trillion, while total mutual fund assets worldwide equal some $25 trillion. If preference for home markets fall, then large capital inflows are likely to flow in to emerging economies.

But it’s not all good news. While the demand is rising, supply is not. The share of EMs in global capital markets is up from 11 per cent in 2002 to just over 14 per cent in 2010. In contrast, their share in global GDP has risen substantially between 2002 and 2010, from 20 per cent to over 30 per cent.

This, according to Citi, suggests financial deepening isn’t taking place at a rate fast enough to increase the supply of EM assets at a satisfactory pace. Effectively it means there probably is too much liquidity chasing too few assets. This will put pressure on asset prices in EMs, till financial markets deepen, claim experts.