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Sometimes You Need To Run Towards The Fire

Q: Should I Sell My Emerging Markets Positions?

Run Towards FireA: If we were going to sell or reduce this position, we would want to do so before the news came out and markets started moving based on the news of strengthen US currency. We don’t want to sell low and buy high. Look at the returns below between the DFA Emerging Market funds and the S&P 500. Keep in mind that markets move on the anticipation of good/bad news yet given how bad the news has been the returns have not been that bad.

DFA Emg Mkt Small Cap

1 month = .21% 

3 months = -2.75%

YTD = -1.13%

1 year = 12.96%

Dividend yield = 2.49%

 

DFA Emg Mkt Core

1 month = -.52% 

3 months = -4.37%

YTD = -2.02%

1 year = 11.96%

Dividend yield = 1.96%

 

DFA Emg Mkt Value

1 month = -.42% 

3 months = -3.11%

YTD = -.22%

1 year = 13.31%

Dividend yield = 2.49%

 

S&P 500

1 month = 4.22%

3 months = 1.9%

YTD = 4.66%

1 year = 16.29%

Dividend yield = 1.58%

 

If we are going to earn the extra premium paid by more volatile assets like emerging markets and small cap, we will have to accept higher volatility, and the dispersion of returns (Emerging Market stocks will rise and fall at different times than US stocks, that’s one of the benefits we get owning them.)  

Currently the US stock market makes up about 52% of the world’s capital markets, emerging markets make up about 12%, while other developed countries make up the other 36%. Owning emerging Markets in your portfolios adds diversification to them because you are able to add over 5,000 positions. Along with that, emerging markets are more volatile and therefore pay higher expected long term returns. Many investors don’t own enough emerging markets because of the risk, but often times adding emerging markets to a portfolio actually improves the portfolios characteristics.

If I can give good investors just one piece of advice, it would be run toward the fire not away from it.  I’m of the opinion that the valuations are so relatively low in emerging markets that the downside risk is relatively small relative to the downside risk in the US.  US assets are priced for perfection.  Values contain all the good news about the tax cuts, the strengthening dollar, etc. and overseas asset values are low, and dividend yields above are 57.5% higher.  The two main places where the emerging market trade will help our portfolios is in the higher dividend yield and the higher volatility as new money is added to the portfolio over time.

Ignore the newspapers, hold on tight to your emerging market positions where our funds work better than indexes, because of how they trade and lend securities.  Disciplined investors will be rewarded in the long term for holding emerging markets in their portfolios because risk and return are related.  Our portfolios are designed to structurally capture this premium. Unfortunately, most of the premium is earned when markets bounce around and scare others out.  One of my favorite Buffet quotes is, “bear markets are when stocks are returned to their rightful owners”.  

We don’t know if markets go down then up, or up then down, but we know where they are going long term, our job is to make sure you get the returns I promised, and the best way to do that is to continue to hold undervalued assets. Emerging markets are one of the most undervalued assets relative to other assets and their long-term averages. Hang in there and don’t give up on emerging markets they are a great asset to own especially if you have access to Dimensional Funds.

Values in this article are based on June 11, 2018

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