A majority of investors’ portfolios are underweight when it comes to emerging market investments, and as a result, investors are missing out on opportunities for higher returns, according to senior executives at Mercer’s investment consulting business.

The executives are gearing up for a two-day investment forum for institutional investors and asset managers in Toronto, which will focus on the growing gap in growth between emerging markets and developed markets. During a roundtable discussion on Monday, they said investors should be paying far more attention to emerging markets.

“Clients should really consider rethinking their investment strategies going forward, and pay more attention to the potential from the east, or emerging economies,” said Yvan Breton, Canada and Latin America leader at Mercer.

Many North American investors tend to invest the bulk of the equity portion of their portfolios in large-cap developed market stocks, according to Divyesh Hindocha, global director of consulting at Mercer. He said a typical equity portfolio has an allocation of just 3% to 5% in emerging market stocks. In contrast, emerging market assets make up 13% or 14% of most global market cap indices.

“The current structural underweight to emerging market equities is something that investors need to revisit,” Hindocha said. “We think it’s more accidental than deliberate.”

Investors are often under the impression that the risks of investing in developing countries are much higher than those in developed countries, the executives noted. But they said it’s important to acknowledge the risks of investing in western economies, as well.

“When a crisis happens, you don’t really have any protection by being invested in the large cap developed countries,” Hindocha said. He pointed out that during the financial crisis, the equity drawdowns in emerging markets were almost exactly the same as those in developed countries.

Furthermore, while developed markets have produced strong economic growth and attractive stock market returns in the past decade, growth in these markets is beginning to slow, the executives said. In the near term, western economies face major challenges in reducing their heavy debt loads, and in the longer term, they face problems related to demographic changes that will impact the workforce.

“We believe that growth going forward will be quite difficult, and in fact, most of the growth will then come from emerging economies,” Breton said.

Still, developed economies continue to hold a number of advantages over their emerging counterparts. Intellectual capital, for example, which is a huge factor in an economy’s development, remains limited in countries such as China, according to Andrew Kirton, global leader of Mercer’s investment consulting business. While China has begun to invest in this type of research, he estimated that it could take decades for the country to substantially expand its intellectual capital capabilities.

“The risk to China is that it’s just such a long process,” Kirton said. “The U.S. is miles ahead of everybody.”

In considering all of the risks that exist, investors should ensure that their portfolios are properly diversified, the executives said.

IE