Australian and Emerging Market Equities: Investors benefit from a relationship breakdown

For some time, investors have contended that an exposure to both Australian Equities and Emerging Market Equities leads to limited diversification benefits, given the high historical correlation between the two equity markets. However, does this remain the case?

20 Nov 2019

Was there a correlation between Australian Equities and Emerging Market Equities?

In short, yes. Zenith believes the relationship was historically driven by Australia’s position as a net exporter of resources, which are highly cyclical and heavily dependent on demand from fast-growing emerging countries. As such, Australia has prospered from the strong growth experienced by Emerging Market economies such as China.
The chart below shows the historical correlations between emerging market equities and Australian Equities as represented by the MSCI Emerging Markets Index and the S&P/ASX 300 Index, respectively.

Source: Zenith, MSCI

Whilst Australian Equities and Emerging Market Equities have historically exhibited strong correlation, this relationship has declined steadily over the past decade. Zenith believes this has been driven by the changing dynamics of China’s economy and its increased weighting in the Emerging Markets index, increasing from less 1% in 1998 to 33% in 2019, as shown in the chart below.

Source: Parametric Portfolio Associates

Following the rapid expansion of the Chinese economy over the period leading up to the global financial crisis, China’s demand for resources has been subsequently overtaken by consumer demand driven by the rise of its middle and upper classes, as shown in the chart below.

Source: ANZ Research

This rapid change in population dynamics and wealth has changed the composition of Chinese consumption, where income is increasingly spent on education, travel, healthcare and aged care. Zenith believes this transformation has been the key driver of the decoupling of Australian Equities from Emerging Market Equities.
In Zenith’s opinion, this change in dynamic allows Australian investors, who typically hold a home bias, to benefit from the increased diversification benefits that Emerging Market Equities offer.

By Quan Nguyen, Head of Equities