The pitch for investing in emerging markets is usually something like - high population growth, an interconnected global economy, and the proliferation of technology will increase productivity and accelerate GDP growth in these economies, benefitting investors. Over the past few decades no country has embodied this pitch more than China. China’s 2001 acceptance into the World Trade Organization was rocket fuel to what is now the world's second largest economy and largest population, lifting hundreds of millions out of abject poverty in the process.
Despite the tailwinds China has had, an investment in the Chinese market has gone almost nowhere over the past 30 years, posting an average annual return of ~1.3%. What were tailwinds have now turned to headwinds. China has a shrinking and aging population, struggles to retain its talent, has a poorly educated population, and is overly reliant on a heavily leveraged property sector that drove past growth.
There are two things that I take away from the chart. First, the GDP growth = stock market performance narrative is erroneous despite sounding rational. Next, how as an investor can you assess the additional risk you are taking when investing in EM? Writer and investor Paul Podolsky says, “Countries compete...for people. Before I consider an investment, I ask -- is this a country that attracts or repels?”. Perth Tolle (creator of the FRDM ETF) invests in a freedom-weighted group of countries based on data provided by the Cato Institute, a unique idea that has performed since inception. While the emerging markets investment case is compelling, the nature of authoritarian regimes is one that can turn an investment into a zero quickly. Proceed with caution.
Note - In this chart the Chinese market is represented by the MSCI China Index (USD). The MSCI China Index has also underperformed the MSCI Emerging Markets Index (6.6% annually).
Sources - MSCI, Jason Zweig