The inclusion of emerging markets in a developed market portfolio : a comparison

Abstract

This quantitative study explores the investment opportunities that emerging markets may offer to investors. This research aims to offer insight as to whether including emerging markets within a portfolio proves to offer performance and diversification benefits to investors, in comparison to developed markets. First off, this dissertation studies the relationship between the emerging markets chosen and their macroeconomic variables to determine factor analysis. Secondly, the researcher delves into the risk-adjusted returns of emerging markets over the period 2005 to 2017, by using metrics such as the Sharpe ratio and the Treynor ratio. Also, the use of cross-market correlations to measure diversification is included. In this study, the S&P 500, the Eurostoxx 50, the Nikkei 225 and the ASX 200 indices represent developed markets, while the IBOVESPA, SSE, BUX, NIFTY 50, JCI, MEXBOL, IMOEX, JALSH and XU100 represent the emerging markets under consideration. In order to conclude a relationship between the developed market indices and emerging market indices, two different types of portfolios are used; an equally weighted portfolio and a risk parity portfolio, where the EM indices are included and excluded respectively. The study’s findings reveal that most of the emerging markets have a high correlation to their macroeconomic variables and hence, should offer diversification potential. Also, it was revealed that emerging markets have achieved superior risk-adjusted returns over both the long-term both individually and within a portfolio. When analysing emerging markets within a portfolio, it was shown that the former led to decreased volatility and higher returns which in turn led to higher Sharpe ratios than a portfolio with only developed market indices. The risk parity portfolio was able to obtain higher Sharpe ratios than the equally weighted portfolio. Thus, the researcher believes that the findings obtained show that emerging markets offer investors great rewards when included within a portfolio, which fundamentally offers further insight to the existing literature on emerging markets.