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Many developed-market companies find emerging markets attractive because of their strong economic growth, favourable demographics, rising middle class, increasing domestic consumption and growing adoption of technology. The International Monetary Fund forecasts that emerging-market economies, which currently account for 75% of global gross domestic product (GDP) will grow by 4.9% in 2018 compared with 2.5% for developed-market economies; by 2020, emerging markets will be growing more than twice as fast as developed markets, at 5.1% vs 1.7%, respectively.

Indeed, developed-market companies are experiencing slower growth in their home markets and see the potential “for double-digit growth rates over multiple years” in emerging markets, says Matthew Strauss, vice president and portfolio manager with CI Investments Inc. in Toronto. In addition, the population of emerging markets is almost 90% of the world’s population, providing an immense market for expansion.

The amount of emerging-market exposure investors could get by investing in equities of developed-market companies depends on the proportion of the companies’ profits that are derived from emerging markets and by how much such profits contribute to their growth.

Developed-market companies included in the MSCI world index derived 21% of their revenue, on average, from emerging markets, according to a 2014 MSCI Inc. report entitled Economic Exposure in Global Investing. North American companies on the index — such as Exxon Mobil Corp., Amazon.com Inc., Apple Inc., Microsoft Corp., Facebook Inc., JP Morgan Chase & Co., and Johnson & Johnson — derived 16% of their revenue, on average, from emerging markets. And European companies — such as Nestle SA, Novartis International AG, Roche Holdings AG, HSBC Holdings PLC and Royal Dutch Shell PLC — earned 27% of their revenue from emerging markets.

Many companies — such as Netherlands-based Airbus Group NV, U.S.-based Colgate Palmolive Co., Germany-based Henkel AG, U.S.-based Mondelez International Inc., Switzerland-based Nestle and Netherlands-based Unilever NV — have a much higher revenue exposure to emerging markets than the average, in the range of 40%-60%.

“Some multinational corporations are more successful than others,” says Christine Tan, associate vice president and portfolio manager with Sun Life Global Investments (Canada) Inc. in Toronto. This is especially the case for Unilever and Colgate Palmolive, consumer goods companies that have decades of experience in emerging markets and are leaders in their respective space in markets such as India and Latin America.

The MSCI report notes that although “some companies may have high international revenue exposures, their revenue might be concentrated in a handful of countries.” For example, U.S.-based consumer discretionary company Yum! Brands Inc. had 77% revenue exposure to international markets in 2014, but 53% of its revenue was derived from China alone, exposing Yum! to the peculiarities of a single market. But many multinationals have exposure to a range of different countries and are consequently not subject to country specific risks.

From a client’s standpoint, investing in these companies just for the sake of getting exposure to emerging markets, may result in missing out on opportunities that direct plays in emerging markets offer. But while developed-market companies might be less volatile, “investors will miss out on the extra tailwind” they can get from investing directly in emerging-market equities, says Arup Datta, senior vice president and head of Mackenzie Investments global quantitative equity team in Boston.

Although emerging-market equities can be volatile, their long-term growth generally is higher than developed-market equities, says Tan, making these stocks a better direct investment.

In addition, some developed-market multinationals have had a successful track record in growing their revenue and profitability in emerging markets, others have found it more challenging, reducing their growth potential.

In some ways, that’s because local companies are beginning to compete head-on with multinationals, Tan says, forcing them to add local content or to partner with domestic companies to gain market share.

For example, companies such as McDonald’s Corp., Starbucks Corp. and Yum!-owned KFC have had to either partner with local companies or change their menu options to adapt to local conditions or to compete with domestic companies, she says.

Thus, it’s no longer smooth sailing for multinationals as emerging markets mature, especially in regions such as Asia, “where there is little opportunity for growth left,” Tan contends.

Clients must recognize that multinationals’ spending in emerging markets actually can result in losses and, therefore, might not be good investments in lieu of emerging-market exposure, Strauss says. Conversely, successful emerging-market companies may reinvest their profits in those regions to support their expansion.

Strauss cautions that investing in developed-market multinationals to get emerging-market exposure in a world that was moving toward globalization was less a risk than in the current environment, in which trade protectionism is more prevalent. Consequently, it might be better to invest in emerging-market companies based locally to get exposure to emerging markets.

At the other end of the spectrum, the risks and inefficiencies inherent in emerging markets will remain, making developed-market multinationals safer bets, with less volatility, says Datta. But it all comes down to the unique risk profile of clients, who must find a balance between investing directly in emerging-market equities and investing in developed-market multinationals to gain indirect exposure to emerging markets.

But there are signs this so-called “home country bias” is beginning to abate. While acknowledging that clients often are more comfortable investing in familiar companies, Ian Riach, chief investment officer at Fiduciary Trust Co. of Canada in Toronto, notes that global investing is beginning to resonate with more Canadian investors. Recognition that global markets offer far more opportunities than Canada does is more common now, he says. “It comes down to showing clients how narrowly focused the Canadian market is,” says Riach, adding that the discussion also should include the pros and cons of global markets. “[Clients] have to recognize the risks as well as the rewards.”

However, if you expect your high net-worth clients to tolerate more offshore risk compared with other clients, you are likely to be disappointed. “There is not much difference in the way both sophisticated and less sophisticated investors view global investing,” Riach says. “A lot of people think that high net-worth investors are more sophisticated, but, in fact, they are more risk-averse.”

One of the best ways to overcome the bias, says Ron Fox, chairman and CEO of Glidepath Portfolio Services Inc. in Toronto, is to tell your clients that investments will be chosen on the basis of superior risk-adjusted rates of return. Fox, whose firm offers separately managed portfolios to high and ultra-high net-worth clients, constructs portfolios that aim to achieve specific objectives without regard to country selection. Most clients do not care about their asset mix, he says, if their investment objectives are achieved.

At the core of the issue with sticking to Canadian investments is the relatively narrow range of Canadian markets. With only three key sectors making up 68% of the public markets – financials, energy and materials – your stay-at-home clients will miss out on potential global growth opportunities in a range of robust industries, such as technology, health care, telecommunications, industrials and consumer staples.

Indeed, says Heather Holjevac, fellow of the Financial Planning Standards Council and senior wealth advisor with TriDelta Financial Partners Inc. in Toronto, staying too close to home can actually increase investing risks. When clients diversify globally, they are more likely to lower their investment risk, says Holjevac, by exposing their portfolios to a range of opportunities in which losses are offset by gains. This strategy, she notes, tends to provide a smoother ride in markets over time.

Riach notes that you should explain that by investing in a global portfolio that holds assets with low correlations, a client’s overall portfolio will tend to carry less overall risk than the weighted-average risks of the portfolio’s individual parts. This can lead to higher returns over time, and allow investment goals to be achieved more quickly.

One way to make these points with your clients is to use historical averages, which show how global markets have performed over time relative to the Canadian markets, says Holjevac. Model portfolios with different asset allocations also can be used to illustrate the benefits of global diversification within different scenarios.

Currency risks also need to be explained to clients who have decided to invest globally. Investing in stocks priced in a foreign currency can either increase or reduce portfolio returns, depending on market movements of both the Canadian dollar (C$) and the foreign currency. If, for example, a client invests in stocks priced in U.S. dollars (which currently trade at a premium of 30% over the C$), those stocks would have to gain more than 30% before the portfolio realizes a positive return in C$.

In addition, foreign investments priced in C$ may change in value independent of share levels. For example, if the C$ weakens against the currency of the investment’s foreign jurisdiction, the value of your client’s foreign investments as priced in C$ will increase (all other things being equal).

Some funds may hedge currency risk by using forward contracts or other derivative strategies to eliminate most of the risk associated with currency fluctuations. This strategy helps provide unitholders with returns closely related to the performance of the stocks held by the fund, independent of currency fluctuations.

Other funds may hedge currency risk only partially, or even not at all, on the assumption that currency movements even out over time.

Emerging markets can vary widely in size, with the stocks of six markets — China, South Korea, Taiwan, India, Brazil and South Africa — currently accounting for more than 75% of the weighting of the MSCI emerging markets index.

“Emerging markets represent one asset class that will continue to grow, that will not go backward,” says Matthew Strauss, vice president and portfolio manager with CI Investments Inc. in Toronto. As the economies of emerging markets continue to mature while their financial services sectors grow, they will create an increasing number of investment opportunities.

One of the key drivers of emerging markets is their rate of economic growth, which is much faster than that of developed markets. The International Monetary Fund estimates that the gross domestic product (GDP) of emerging markets for 2018 will grow at double the pace of developed markets: 4.9% for emerging markets vs 2.5% for developed markets. That gap is expected to widen, with estimated GDP growth of 5.1% in emerging market vs 1.7% in developed markets in 2020.

Emerging markets, as a result of their higher growth rate, account for 75% of global GDP growth, says Christine Tan, associate vice president and portfolio manager with Sun Life Global Investments (Canada) Inc. in Toronto.

Chetan Sehgal, senior managing director of Franklin Templeton Emerging Markets Equity in Singapore, a division of Franklin Templeton Investments Corp., suggests that emerging markets are benefiting from several factors, including “a supportive global macro backdrop, improving economic fundamentals, ongoing reforms, a favorable earnings outlook and attractive valuations.”

Emerging markets also are “better managed than in the past,” and the risk traditionally associated with investing in them has declined, says Arup Datta, senior vice president and head of Mackenzie Investments’ global quantitative equity team in Boston. Although emerging markets still areperceived as risky, he adds, that perceived risk is typically associated with higher long-term returns.

“The structural case for emerging markets continues to center on demographics, a rising middle class, domestic consumption and the growing adoption of technology,” Datta says.

Many countries also have benefited from “reformist, business-friendly governments that seek to reduce bureaucratic barriers to economic growth and encourage entrepreneurship,” he adds.

Tan points out that many emerging market countries have a rising middle class and a younger demographic, which can have a positive effect on their economies in the form of higher incomes, increased consumer spending and accelerated infrastructure development.

Sehgal adds that businesses in emerging markets are improving, as well.

“Emerging markets companies have undergone a significant transformation,” Sehgal says, “from the often plain-vanilla business models of the past, to a new generation of innovative companies that are moving into technology and higher value-added goods and services.”

Tan and Datta note that emerging markets are not a homogeneous asset class, and they are at various stages of development. “It would be a mistake to lump all emerging markets into a single asset class,” Datta says. “Some are mature, and some are early-stage.”

For example, Tan says, India has a relatively young population, which has contributed to strong growth in consumption. China, on the other hand, has an aging population that has resulted in higher consumer spending in areas such as health care and travel.

Strauss advises that when investing in emerging markets, you have to consider the region, the country and the sector. For example, Latin American markets and South Africa are endowed with natural resources and are most vulnerable to a decline in commodities prices.

Strauss notes that changes in commodities prices can affect different emerging markets in different ways. “Lower oil prices, for example, are bad for producers,” he says. “Higher prices are bad for net importers such as Turkey and India.”

But, Strauss adds, commodities are no longer a core theme when looking at emerging markets

Countries such as India and China, which are more reliant on exports, can be affected by a global downturn and by issues such as trade protectionism, which has reared its head under the Donald Trump administration in the U.S.

But most emerging-markets companies now also have a domestic component to their growth, Strauss says, and are becoming less reliant on exports.

Although commodities production and exports remain important to certain emerging-market economies, Strauss says, emerging markets have been shifting toward “new economy” industries, underpinned by innovation and consumption.

“Many investors continue to view commodities as the dominant driver of emerging markets,” Strauss says, “but we consider this a misperception.”

This is the first in a four-part series on investing in emerging markets.

“Financial advisors must plan in advance to mitigate the effects of disruptions or, in certain cases, to minimize the likelihood of their occurrence,” says Subhas Fagu, partner with Techlicity Ventures Corp. in Toronto. “[Advisors] must have a sound understanding of the potential impact of any disruptive event and develop welldefined processes and procedures to deal with such events.”

Regulatory bodies such as the Ontario Securities Commission (OSC), the Investment Industry Regulatory Organization of Canada, the Mutual Fund Dealers Association of Canada (MFDA) and the Canadian Securities Administrators require that business continuity be an ongoing priority for investment industry participants. The regulators recognize the substantial risk that major disruptions can pose to the financial services sector and the potential for loss of confidence among investors.

To put the requirement for business continuity management into perspective, an OSC staff notice states that plans must incorporate a “whole-of-business approach that includes policy, standards and procedures for ensuring that specified operations can be maintained or recovered in a timely fashion in the event of a disruption.” The notice adds: “Effective business continuity management concentrates on the impact as opposed to the source of the disruption.”

Although business continuity planning and disaster recovery planning often are mentioned together and usually are covered in the same plan, the terms have slightly different meanings.

“Business continuity” refers your ability to keep your business up and running during a disaster and to get back to normal with as little disruption as possible after an event.

“Disaster recovery” refers to your ability to restore key data

necessary to run your business should your systems be damaged.

Both components of disaster planning are equally important.

In addition to requiring that you have both business continuity and disaster recovery plans in place, the OSC requires that you test your business continuity plans periodically. You also are responsible for ensuring that your thirdparty providers, such as back-office systems and cloud-storage

services, have adequate disaster recovery capabilities. And you must conduct reviews of the quality of any outsourced services. “[Advisors] must have some degree of contingency planning in place to be able to deliver the same level of service under adverse conditions,” says Des O’Callaghan, an independent business continuity management consultant in Toronto.

To begin with, he says, you must aim to prevent disruptions and, if they occur, “have the processes and capabilities in place to continue to operate or to recover as quickly as possible.”

Larger businesses may have more sophisticated plans, which are more costly to maintain and operate. But plans for smaller businesses, such as financial advisory practices, don’t have to be expensive, O’Callaghan says.

“Regardless of the size of the organization,” O’Callaghan says, “any business continuity measures must be cost-effective.”

The MFDA recognizes that differences in scale of operations should dictate the level of planning required. An MFDA staff notice states that firms must develop business continuity plans that are appropriate for their size and business model.

Still, cost can be a constraint for many advisors, says Montu Chadha, president of Applications On Network Inc., in Richmond Hill, Ont. Smaller businesses generally maintain the minimum requirements for business continuity and disaster recovery. “[These businesses] want to do more,” Chadha says, “but are faced with budgetary constraints.”

Many advisors may not have internal resources to prepare their plans and, consequently, must seek outside help.

“You have to start from somewhere,” Chadha says. “Have a practical budget and speak to someone who has done it before.”

PREPARING YOUR PLAN

Your integrated business continuity and disaster recovery plan must describe clearly the steps you and your team will take to deal with disruptive events. The plan must answer the following questions:

– What are your critical business functions? For example, do you maintain and conduct trades in client accounts? Do you hold personal client information?

– Do you have a list of contacts, including contact information for individuals with specific responsibilities in the event of an emergency?

– Have you identified an alternative site from which you can operate in case you don’t have access to your office?

– What are the other roles and responsibilities of your staff members in an emergency?

– Who is responsible for recovering client data following a disruptive event?

– Who are your third-party service providers, particularly those who handle your data?

– Where and how is your data stored?

– How can you access your stored data should an emergency happen?

– How quickly can you recover the data you maintain in order to continue serving your clients?

– What assurances do you have that you can recover your data readily?

– How frequently do you test your ability to recover your data?

“Planning involves intelligent thinking and doesn’t have to be terribly complicated,” O’Callaghan says. “You must establish priorities and emergency procedures in case of a disruption.”

Your plan is basically a series of “what if” scenarios for various occurrences.

Communicate your plan to your staff and update it regularly to reflect changes in your business operations, including system and service-provider changes.

From an operational standpoint, your plan must be tested periodically at least, annually to ensure that you can handle a disruptive event. Testing must be conducted in collaboration with third-party providers, such as your off-site back office or your data backup and storage site.

Some key considerations to take into account:

IDENTIFY POTENTIAL THREATS

Business disruptions can come in different shapes and sizes, Fagu says. For example, the challenges of continuing to operate your business after a fire would be different from working through a cyberattack.

In the case of fire, you might have to find new premises at least, temporarily and replace computers and other equipment.

After a cyberattack, you must take steps to recover data and deal with systems security and software issues, such as firewalls and virus protection.

That is why you have to conduct an analysis of all potential threats.

“You must have some awareness of what can happen,” O’Callaghan says, “and some kind of emergency plan to deal with the resulting disruption.”

Consider the types of events that are most likely to occur in your operating environment, Chadha says. For example, depending upon your geographical location, you may be unlikely to experience an earthquake or a tornado, but might need to deal with a flood or a sustained power outage.

CONDUCT A BUSINESSIMPACT ANALYSIS

Whatever the source of the potential disruption, you must analyze how it will affect your infrastructure, Chadha says.

Fagu adds that you will need to identify and prioritize business functions that must be recovered in case of an emergency.

One of the most important components of a financial advisory business is its technology infrastructure. The infrastructure maintained by your third-party service providers is equally important.

You must ensure that your computer systems are configured in such a way that you can recover important data and client records quickly and easily.

You must be able to validate the recovery capabilities for your information through regular testing, Fagu adds.

DATA STORAGE, BACKUP AND RECOVERY

Storing and backing up data are important elements of both business continuity and disaster recovery.

“There is a real cost, as well as time and effort, associated with data storage and backup,” Chadha says. So, you should back up only data that are critical to your operations.

To make this distinction, you must categorize data based on relative importance, he says. This step would make recovery of key data in an emergency easier. Access to marketing materials, for example, would not necessarily be as critical for business continuity as applications and client data are.

Generally, data can be backed up locally, off-site, remotely or in the cloud. Each method has advantages and disadvantages. “There is no single solution,” Chadha says.

Smaller businesses, Fagu says, often back up and store data on their own servers, external hard drives or USB drives. Alternatively, third-party servers, which are convenient and relatively inexpensive, could be used.

However, Chadha cautions, data backed up on portable drives are susceptible to corruption and can be lost or exposed to unauthorized access if they’re not encrypted.

“A lot of companies back up data, but often can’t recover [the data] when required,” Chadha says, “because the tools [aren’t there].”

For example, you may not have the software to recover certain accounting records. So, you must ensure that you have the ability to recover your data on demand.

Chadha recommends using an automated system for storage and backup that is available and accessible at all times.

Cloud storage is one solution. “When you use the cloud,” Chadha says, “your data can be accessed at any time from multiple locations, enabling easy recovery.”

However, he cautions, cloud storage can be costly and you must select your provider with care. Also, your data will be in “somebody else’s hands” and may be subject to security threats.

DETERMINE ROLES AND RESPONSIBILITIES

In the event of a disruptive event, you must determine how you and your staff will continue to do your jobs and how you will communicate with clients and service providers.

You also must establish who is responsible for managing the business continuity and disaster recovery plan.

“In the case of smaller advisory businesses,” Fagu says, “the owner would most likely have to take control.”

For larger businesses, staff must be assigned key responsibilities, together with alternates in case the primary staff member is not available. You also must establish a platform and methods for communicating with clients, third parties and staff if your existing infrastructure is not available.

For many advisors, the requirements for business continuity and disaster recovery planning might appear quite onerous. But, from a regulatory standpoint, you have an obligation to have a plan.

“Just think about your own business model,” Fagu says, “and what you would do if disaster strikes.”