Why Emerging Market Equities Belong in a Diversified Investment Portfolio

Abstract

The decision to expand an investor's portfolio into emerging markets is often difficult due to the risks involved. The benefits of adding emerging market equities to a globally diversified portfolio are examined with semideviation and downside beta, useful measures of downside risk in investments. Using the MSCI World Index as a proxy for the developed market portfolio of globally diversified investors, MSCI Emerging Market returns are shown to improve the risk/return profile of the diversified investment portfolio. The returns from emerging market investing have been superior to the required returns from both the CAPM and the downside CAPM. Improvements to the Sharpe ratio and the reward-to-semideviation ratio are found for portfolios which include sizable allocations to the emerging markets.