Portfolio Design: A Modern Approach to Asset Allocation

SUMMARY—KEY FEATURES OF EMERGING MARKET STOCKS AND BONDS

The world’s stock and bond markets are divided into developed and emerging for a good reason—emerging markets are riskier. The dividing line between the countries themselves is somewhat arbitrary, but the division between the assets of these two sets of countries is a meaningful one. Standard deviations have been a step above those of developed stock markets. Consistent with higher risks, emerging market stocks have delivered stellar returns since the series began in the mid-1980s. And these stocks also provide diversification to a more traditional portfolio.

Unlike emerging market stocks, emerging market bonds seem too good to be true. The returns since the early 1990s have been better than stock returns with standard deviations below those of the S&P 500. This chapter has argued that the returns are due to a dramatic downward assessment of risks. This reassessment has provided once-for-all returns much like we have enjoyed from the reassessment of inflation in the U.S. bond market. Emerging market bonds, like their stock counterparts, are crisis-prone. But many investors will not believe this until the next crisis occurs. Caveat emptor.

NOTES

1. The term submerging markets is due to Goetzmann and Jorion (1999). These authors examine stock markets like those of Argentina and China that re-emerged after decades of closure due to political instability. The term frontier market is given to a subset of emerging markets at lower ...