Emerging markets have suffered for some time under the weight of the prolonged slump in commodities and the growing strength of the U.S. dollar.
Nonetheless, there are growing signs that emerging markets are set to rally strongly over the course of 2017. The MSCI Emerging Markets Index has already surged in recent months to now be up by 25% over the last year.
There are three key reasons why Canadian investors should have emerging markets exposure in their portfolios.
Firstly, a key consideration for investing in emerging markets is the ability for investors to further diversify their portfolios.
This is particularly important for Canadian investors because the TSX is heavily weighted to financials and energy stocks, making up 36% and 23% of the market, respectively.
Diversification is an important tool for managing risk — even more so when considering that emerging markets tend to be less correlated to developed markets, which means they don’t move in unison with those markets.
As a result, economic and/or geopolitical events that have the potential to trigger a sharp market correction on the Canadian or U.S. stock markets have less of an impact on emerging markets.
Secondly, emerging markets possess a range of favourable characteristics that increase the potential for strong future growth.
Key among these characteristics are favourable demographics and growing consumption.
You see, roughly 80% of the world’s population lives in emerging markets, and those populations are not only quite young in comparison to developed economies, but they are experiencing increasing standards of wealth. This means that as those nations develop and wealth increases, consumption will grow strongly.
Such strong growth potential coupled with the lower correlation to developed markets helps enhance investors’ returns.
Finally, emerging markets typically experience higher rates of economic growth.
You only need to turn to India, China, or Colombia to see this. Between now and 2020, India’s economy is expected to expand at annual average of 7.8%, China will expand at 6%, and Colombia will expand at 3.8%.
These rates of growth are far greater than the 1.9% forecast for Canada and the 2% for the U.S.
Those substantial rates of economic growth will translate into faster earnings growth for companies operating in those countries. That earnings growth coupled with favourable demographics means greater profits for those companies.
When investing in emerging markets, investors need to ensure they understand the additional risks posed; the key to managing that risk is patience. Another way to manage that risk while obtaining the benefits that emerging markets offer is by investing in Canadian companies that have considerable exposure to developing economies.
One company that stands out is Brookfield Infrastructure Partners L.P. (TSX:BIP.UN)(NYSE:BIP). It owns a broad portfolio of hard infrastructure assets across developing and developed countries, giving it exposure to India, Brazil, Colombia, and China.
Notably, the ever-widening trillion-dollar gap between the demand for infrastructure and shortage in investments will act as a powerful tailwind for Brookfield. This growth potential is enhanced by its solid record of recycling capital. Brookfield is actively making acquisitions, driving efficiencies from those businesses, and selling them at a profit.
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Fool contributor Matt Smith has no position in any stocks mentioned. Brookfield Infrastructure Partners is a recommendation of Stock Advisor Canada.