Are there still opportunities in emerging markets?

Rock Caspar Architas 2014

Caspar Rock is CIO at Architas

Despite the fact that emerging markets now represent 40 per cent of global GDP, the emerging market stockmarkets account for barely 10 per cent of the MSCI World Index. These less sophisticated markets are perceived as more volatile and risky than their developed market counterparts such as FTSE 100 and S&P 500, with some justification.

The opening weeks of trading for 2016 in emerging market stock markets have given a clear indication as to why that might be. Markets have lurched downwards stung by the double backlash of developed market growth fears and tumbling commodity prices.

Technical factors can also have a knock-on effect, such as the infamous “circuit breaker”, which forced the Chinese stockmarket to close at its low after a 7 per cent fall, allowing only 15 minutes of trading on two separate jittery days. In such circumstances, investors looking to lighten exposure to Asian emerging market equities had no choice but to switch their sell orders to neighbouring markets, resulting in a regional rout.

We remain underweight emerging market equities and debt. However, within our allocation to emerging market equities, we favour global rather than regional emerging market funds that offer a degree of downside protection. One of our favoured funds is the Fidelity FAST Emerging Markets fund. Run by seasoned investor and accountant by trade, Nick Price, this fund offers an excellent long-term, quality growth approach to investing in emerging markets via companies that provide high returns on capital. The team and track record behind this fund are impressive, and its shorting capability enhances the potential for alpha and downside protection.

We also like the Aberdeen Emerging Market Equity fund, which likewise takes a long-term, quality growth approach, very much in line with the Aberdeen philosophy. The team concentrate on fundamental analysis and aim to be active shareholders in all companies in which they invest, following a disciplined investment process. Although the fund is large in terms of assets under management, Devan Kaloo, Aberdeen’s head of equities, skilfully guides the impressive team of dedicated analysts and the fund’s long-term performance is excellent.

YeowartTom

Tom Yeowart is a fund manager at Troy Asset Management

Emerging market equities have had a torrid time over the past few years, beset by a confluence of factors. The headwinds of rising US interest rates, a strong dollar, slowing economic growth and weak commodity prices could persist for some time.

Moreover, if China slows more rapidly or debases its currency more aggressively than expected, emerging market equities are likely to suffer greater dislocation. However, we believe that valuations and currencies have weakened to a point where investors should begin to weigh the short-term risks against longer-term prospects. Although our emerging market weighting remains relatively low, we have been adding to it and would do so enthusiastically if capital flows out of emerging markets slowed and currencies stabilised.

It is important to be selective. The emerging market concept is a marketing construct that obfuscates marked differences between constituent countries and companies. Instead of investing indiscriminately, we prefer to invest with active and discerning fund managers who focus on the underlying quality, durability and value of the companies in which they invest.

In the Spectrum Fund, we have recently added to our holdings in Findlay Park Latin American and Halley Asian Prosperity. Both Rupert Brandt and Greg Fisher, the respective managers, are excellent custodians of capital with significant experience and knowledge of the markets they invest in. Their portfolios trade on undemanding multiples and invest in good quality, cash generative companies that should continue to grow and prosper despite the difficult economic conditions. While the short-term pain may get worse, volatility also presents wonderful opportunities for the long-term investor.

SchotanusPatrick

Patrick Schotanus is global strategist at Kames Capital

There are currently two aspects that are favourable for emerging markets: valuations and positioning. The former is improving and the latter is very underweight.

However, the broader backdrop for emerging markets is not positive because of slowing global growth, capital outflows, tight monetary conditions and the various feedback loops between them. The impact of slowing growth, for example in China, is reflected in falling commodity prices and is impacting emerging market commodity exporters, such as Latin America and the Middle East and Africa.

Among the consequences is the depletion of FX reserves, previously built up at the time of a rising global savings rate. It means, for example, that the drop in the oil price forces petro-dollars to return home.

Third, combined with the threat of further Fed hikes, the continued strength of the US Dollar versus emerging market currencies means that emerging market entities that have increased their (at the time, cheap) dollar funding are now feeling the pressure.

One response is to raise rates in order to prevent further depreciation, such as inflation, or even a funding crisis. But that risks hurting growth even more. Add in potential political turbulence and the assessment suggests caution. We would therefore only allocate highly selectively in both emerging market debt and equities.