Investing beyond the US

In the past four decades, emerging markets have almost doubled their share of world economic output


At the start of the 20th century, one stock market stood head-and-shoulders above the rest. Britain was the centre of global investment, accounting for fully one-quarter of the value of stock markets worldwide. The US represented 15%. Now, the US stock market is by far the world’s largest: its value accounts for more than half the global total. In second place is Japan and Britain accounts for a much-diminished 5.5%.

In the 119 years since 1900, the US economy has grown more strongly than the rest of the world. But the US dominance of the world’s markets carries with it the danger that too much is inferred about the performance of equities globally from what has happened in this one country. There is, after all, an investment world beyond the US borders.

IPOs and the growth of the US economy over the past 119 years have played their part in boosting the size of the country's equities market. Nevertheless, the returns on American equities have been an important contributor. They have been strong both in nominal terms and after taking inflation into account: in real terms, returns from US equities, at an annualised 6.4%, were far higher than those on bonds or bills.

But equities in some other markets have done better. In real, local currency terms, the US was beaten by Australia and South Africa. Furthermore, the returns from equities in the US weren’t vastly higher than those in the rest of the world: excluding the US, equities returned an annualised 4.3%. A striking factor is also that the best-performing equity markets over the past 119 years tended to be in resource-rich and/or New World countries.

Now let’s look at the more recent past. What has happened since 1980? It is no longer sufficient for investors to concentrate only on developed markets. The shape of the global economy has changed.  So has the shape of the potential investment universe.

“There is, after all, an investment world beyond the US borders”

Over the past four decades, emerging market (EM) nations have virtually doubled their share of world economic output from one quarter to almost one half. (This is after correcting for price differences between countries, making an allowance for so-called purchasing power parity or PPP.)  Meanwhile, the proportion of global output accounted for by developed market nations has fallen from just over 60% to 37%.

This split is not reflected in the size of equity markets available to global investors. As described above, the US market is by far the most valuable in the world; yet China is now the world’s largest economy when measured in PPP terms. Nevertheless, China’s stock market – or at least that part of it in which global investors can buy shares – represents only 3.4% of the value of markets worldwide.

Several reasons explain this apparent inconsistency. Shares in some EM countries are inaccessible to international investors; and the average ‘free float’ – the proportion of companies’ shares that are freely traded – is much lower in emerging markets than in developed ones.

But even after taking these factors into account, emerging markets and their smaller sisters, ‘frontier markets’ – those too small, risky or illiquid to be called emerging – have increased their combined weighting in global equity indices six-fold since 1980 to reach around 12% by the start of 2019.

What is striking is how small this figure is – even today. After all, emerging market nations – those included in the MSCI Emerging Markets index – account for virtually half of global PPP GDP and almost 60% of the world population.

So how have emerging markets performed relative to their developed counterparts? Long-term comparisons are complex.  And the picture of long-term performance is heavily skewed by what happened in the years just after the Second World War, which were terrible for EMs. Between 1945 and 1949, equities in Japan – then categorised as an emerging market – lost 98% of their value in dollar terms; in China, the Communist victory meant investors lost everything in 1949 when markets were closed.

But between 1950 and 2018, EMs staged a recovery, albeit with setbacks along the way. Over this period of almost seven decades, they achieved an annualised return of 11.7% compared with 10.5% for developed markets.

“Does that mean that over recent years, China has been a star performer for investors? Not at all.”

Of the 24 constituent countries of the MSCI Emerging Markets index at the end of 2018, China was by far the largest, with more than twice the weighting of its nearest rival, Korea. Does that mean that over recent years, China has been a star performer for investors? Not at all, in spite of its staggering economic growth. 

There are several different indices that give wildly varying figures for the performance of Chinese equities. However, according to the most comprehensive index, between 1993 and 2018, the real return (measured in dollars) from investing in China was an average 5.1% a year. That is only fractionally above the average for emerging markets as a whole, and slightly below the figure for developed markets.

Within today’s top ten EMs, the best performer was Brazil over the quarter-century to 2018, with an annualised dollar return of 11%. Russia, South Africa and India also out-performed China.

Today’s emerging markets are dominated by larger, global companies. Much of their revenues and profits come from abroad, so their fortunes are linked to other global equities. Similarly, many of today’s largest companies in developed markets have substantial operations in EM nations: this provides indirect access to emerging economies.

But even though global markets are becoming increasingly interconnected, there are still significant benefits from spreading assets across both emerging and developed markets. The typical developed market investor can reduce risk by holding EM assets and, for an EM investor, the benefits from diversifying abroad are even greater.


7 curious facts about global equities

  • Switzerland has just 0.1% of the world’s population, but the world’s eighth-largest equity market, accounting for 2.7% of total world value. Just three companies, Nestle, Novartis and Roche, account for more than half the value of the FTSE Switzerland index. Since 1900, Swiss inflation has averaged just 2.1% a year – the lowest of any country in the world.
  • German equities lost two-thirds of their value in the First World War. In 1922-23, inflation hit 209 billion percent. The Wirtschaftswunder (economic miracle) of the years 1949-59 as the country recovered from defeat the Second World War saw German equities rise by 4,373% in real terms.
  • France’s economy is Europe’s second largest after Germany. It has the biggest equity market in Continental Europe. At the start of 2019, France’s largest listed companies were Total, Sanofi, LVMH and L’Oreal.
  • By the beginning of 2019, financial companies represented nearly half (45%) of the Austrian stock market index. Of the countries for which data are available, Austria has been the worst-performing equity market over the years from 1900 to 2018, with real annualised returns of just 0.8% a year.
  • Between 1900 and 1939, Japan was the world’s second-best equity performer. Defeat in the Second World War meant stocks lost 96% of their value. A bubble in the early 1990s meant that Japan’s equity market was briefly the largest on the planet, meriting a 41% weighting in the world index. Then the bubble burst: from 1990 to the start of 2019, performance of Japanese stocks was dismal.
  • Inflation in the Netherlands has been consistently low: since 1900, the country has had the lowest rate of price rises of any country in the European Union. Its stock market has a heavy exposure to consumer goods: at the start of 2019, this sector accounted for 26% of the market’s capitalisation.
  • Russia’s stock market is dominated by resources, including oil and gas and basic materials. At the start of 2019, some 63% of the market comprised oil and gas companies, most notably Lukoil and Gazprom.
  • From the Credit Suisse Global Investment Returns Yearbook 2019 by Elroy Dimson, Paul Marsh and Mike Staunton.

Elroy Dimson and Paul Marsh are both Emeritus Professors of Finance at London Business School. Mike Staunton is Director of the London Share Price Database at London Business School.


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