LONDON (Reuters) - One of the hardiest investment fixtures has been the annual ‘buy’ note on emerging markets equities, but their dismal performance over the past decade begs the question why.

FILE PHOTO: Traders work on the floor at the New York Stock Exchange (NYSE) in New York, U.S., December 17, 2019. REUTERS/Brendan McDermid

With the United States and China poised to seal an initial trade deal, the chances of a global recession receding, and U.S. equities soaring to record levels, many investment firms are once again turning positive on emerging markets for 2020.

That seems logical in a low-growth, low-yielding developed world, where underlying bullishness about equities may reasonably be guided toward relatively high dividend and growth stocks in a grouping of developing economies now accounting for around 60% of global economic activity and expected to be the main engine of what little growth there is around.

But the re-emergence of the seasonal cheer toward emerging markets doesn't wash as easily as it once did and contrasts with the rest of the year, in which returns on emerging market stocks have disappointed - less than half those of Wall St's S&P 500 .SPX and more than 10 percentage points below MSCI's all-country world index.

Some bets go wrong once in a while. But it’s been like this for emerging markets for much of the past decade.

In every year apart from 2010 and 2017, the MSCI Emerging Markets Index .MSCIEF has trundled in behind the plain vanilla U.S. benchmark index, raising questions as to why advisers continually push ostensibly higher-risk markets that reap poorer returns.

“This time of the year, every single year, you get the same people...trotting out the same argument as to why you should buy emerging markets,” said John-Paul Smith of emerging market consultancy Ecstrat, who has correctly called the underperformance of emerging stocks from the end of 2010.

HIGH RISK WITHOUT THE REWARD?

Once dismissed as “casinos” because of their volatile economics and politics and frequent illiquidity, emerging markets have sucked in an estimated $50 billion annually in foreign equity flows since that term for lower and middle-income countries was first coined 38 years ago.

That investment has helped emerging economies develop, with at least some of that cash ploughed into infrastructure, local business and public services.

For much of their early years, emerging markets proved the brightest stars in the global asset class galaxy - surpassing the S&P 500 up until the 2008 global financial crisis.

But the last decade has been more subdued.

Investors broadly give three big reasons for that. A stronger dollar, due in part to U.S. attempts to dial down stimulus in the wake of the 2008 banking crash, has acted as a headwind for further migration of still-dominant western private savings pools toward emerging markets.

More tepid global growth has also magnified a slowdown in China - whose explosive expansion from 2000 was the supercycle of the previous decade but which has since dragged on all emerging economies.

Thirdly, the failure of globalization to fully recover from the 2008 banking crash and recession - evident in a rash of protectionist politics, civil unrest and faltering trade - has weakened the underlying 30-year investment thesis.

“In this environment trade has suffered,” said Ian Hargreaves, co-head of Asia and emerging market equities at Invesco. “Given the correlation between exports growth and corporate earnings for EM companies, this has had a negative impact.”

KEEPING THE FAITH?

Nevertheless, heading into 2020, BlackRock - the world’s largest asset manager - is overweight on emerging market equities. Amundi Asset Management, Europe’s largest, is “moderately more constructive” on the asset class. JPMorgan, the U.S.’s largest bank, is modestly overweight, while HSBC Asset Management, part of Europe’s largest bank, is overweight too.

Many within the industry were similarly positive going into 2019 and in many recent years. BlackRock and HSBC Asset Management were overweight this time last year, Amundi was neutral, while JPMorgan expected emerging market stocks to deliver double-digit appreciation - which they have done, just almost half the amount you would have got at home in Boston, London, Paris or Frankfurt.

“The fund management industry push the emerging markets largely for reasons of self-interest because the margins are so much higher,” said Smith.

For a graphic on Dismal decade for emerging market stocks, click

STRUCTURAL CHANGES

Their poor performance is raising broader questions about the structure of stock market indexes like MSCI’s, the most-widely used emerging market index, with around 1,100 constituents from 26 countries.

Such indexes should begin to encompass U.S. giants such as Boeing BA.N, Coca-Cola KO.N or Chevron CVX.N as emerging markets begin to account for a larger chunk of their profits, said veteran emerging market investor Mark Mobius. Developed market stocks are not currently included, although MSCI does offer separate indexes which cover such stocks with high exposure to emerging markets.

“You can continue to say emerging market countries are in the lower and middle-income bracket but if a company has more than 50% of its earnings in emerging markets it should be defined as an emerging market company,” said Mobius, founding partner of Mobius Capital Partners.

Some emerging market companies have performed well over the past decade. South Korea's Samsung Electronics 005930.KS, for example, has shot up more than 300%, although still less than Apple AAPL.O and Microsoft MSFT.O.

For a graphic on Dismal decade for emerging market stocks, click

MSCI says its framework for classifying markets into emerging and developed is supported by evidence showing that splits based on development and geography resulted in correlation clusters, allowing investors to seek out diversity.

“Superior economic growth has resulted in positive market returns historically, low correlation within emerging markets and across asset classes has provided diversification benefits, and relative scarcity of information has created opportunities for active portfolio management,” said Dimitris Melas, MSCI’s global head of core equity research.

Melas points out that emerging markets have outperformed since the launch of the MSCI Emerging Markets Index in December 1987.

INVESTMENT BOOM

The 80s were the start of an investment boom in emerging markets, which gained traction after the IFC’s Antoine van Agtmael pitched a fund investing in such markets in a meeting at investment bank Salomon Brothers in New York. He piqued the interest of those present but doubts surfaced about the proposed name “Third World Equity Fund,” a term that connoted poverty and hopelessness.

Agtmael coined emerging markets, instead. Soon the likes of Franklin Templeton and Capital Group were dipping their toes in the asset class, at the vanguard of a growing wall of investment.

“It still makes sense to group together the lower-income end of the global investment universe and it has not stopped ‘emerging’,” said Agtmael. “In fact, it may be bigger and more attractive than ever now that it is no longer ‘hyped’.”

Emerging markets remain a growing part of the global economy with a rising middle class, unlike the U.S., he notes.

Fund managers are split about the asset class’s fortunes over the next decade.

Ecstrat’s Smith remains downbeat, worrying in particular about the risk of a blow-up among “too big to fail” state-linked firms in China.

Others are more positive.

“In the last three months emerging markets have outperformed the S&P 500,” said Mobius. “We may be seeing a return to emerging markets mainly because of this low interest rate environment. People are searching for yield.”

But if that yield is drowned by repeated capital loss, illiquidity or excessive volatility, the burden of proof will climb further.