BlackRock: Investors Need To Fundamentally Rethink What It Means To Invest In The Emerging Markets

While emerging markets account for 51% of global GDP, they represent only 12% of global stock market capitalization, according to BlackRock.

This means there's tremendous room for growth and opportunity for investors. But this also doesn't mean that the countries with the highest GDP growth offer the best returns.

BlackRock's Jeff Shen and Rodolfo Martell write that investors interested in emerging market stocks should realize the landscape has changed, and that "for investors who want to develop their portfolios, the developing world is an unmatched source of potential.."

"Investors may need to fundamentally rethink what it means to be an investor in emerging markets. The same methodologies that served them well since MSCI launched the first comprehensive EM index 25 years ago may not provide adequate risk-adjusted returns over the next 25. In fact, the MSCI EM Index represents only 4% of the stocks listed in the emerging world. The MSCI EM Small Cap Index covers an additional 9%. We're not suggesting it would be possible, or even desirable, to track all 18,000 listed EM stocks. But we strongly believe there is great opportunity to add value through in-depth research and security selection. We suggest equity investors re-examine their holdings both at the broad index level and the individual security level.

"We would also point out that EM investing entails more than investing in companies that are domiciled in developing countries. In an era of increasing globalization, many companies located in the developed world derive a significant portion of their revenue from the emerging world, while the reverse holds true for many companies headquartered in EMs. As companies expand their footprint globally, their revenues become more diversified. You need not invest in an EM-domiciled country to benefit from EM growth."

In terms of emerging market debt they write that what was "once considered a high-risk, niche asset class, should be considered a prime candidate for inclusion in a diversified portfolio."

"In addition to the improved fundamentals, investors may also find that an allocation to EM debt helps to capture some of the exposure to GDP that is missing from their equity approach."

The average investor is underweight EMs and has an allocation of only 5%. Shen and Martell think this should be closer to 18%.