Investors eager to capitalise on the growth of emerging economies but wary of their intrinsic risks should try to reap the benefits of the emerging market consumer through western companies listed on developed exchanges, says Bank Sarasin in its latest report.

The Swiss bank singles out the example of Yum! Brands, the US company that owns Pizza Hut, Kentucky Fried Chicken and Taco Bell, with just over a third of its revenue coming from the US market.  

Sarasin points out that western consumers are over-borrowed and overspent whereas emerging market consumers are on the rise. The World Bank predicts emerging markets to grow by 6 per cent this year and the next, while the forecast for developed countries is 2.5 per cent. In 1990, emerging markets made up 42 per cent of the world's GDP at purchasing power parity. The figure is ten percentage points higher today and, according to some projections, it could reach 70 per cent by 2030.

Even if the potential for growth in developed countries looks meagre, Western economies offer high standards of market conduct, albeit without being free of bankruptcies. Developed market exchanges and institutions are better regulated and market practice more transparent than in emerging market counterparts, which are unstable by comparison, Sarasin notes.

Changing of the guard

The time when emerging markets only formed a tiny chunk of investors’ portfolios is gone. It was once seen as a high-risk investment strategy, as a result of the Mexican crisis in 1994, Thailand’s currency devaluation in 1997, which spread contagion across Asia, the Russian debt crisis of 1998 and the Argentine peso crisis in 2002. However, the financial meltdown of 2008 and its roots in Western markets turned established thinking on its head.

Sarasin argues that emerging markets should be an integral part of every investor’s portfolio, but there are pitfalls to look out for. Tracking emerging market indices can be a dangerous strategy. For example, exchange-traded funds are accessible and cheap but often only allow exposure to the largest and most liquid emerging market companies. Sarasin warns against sweeping allocations to these companies as they are more affected by world events and Western markets than by the local consumer. For example, two out of the five biggest companies in the MSCI Emerging Markets Index are oil companies: Gazprom and Petrobras.  

At the same time, Sarasin highlights that equity markets have paid little interest to the geopolitical arena in the first half of 2011, a period when almost everything that could go wrong did go wrong: natural disasters in Japan, political turmoil and war in the Middle East and North Africa, another sovereign debt crisis in the eurozone, and the lack of a funding agreement for the trillion dollar US deficit.

Sarasin also warns against lumping all countries and companies into a single indiscriminate bundle, especially with the backdrop of the growing talk of an unsustainable Chinese housing bubble. Moreover, the bank highlights that the BRIC countries (Brazil, Russia, India and China) are widely different countries, with Russia having ten times higher income per capita than India.