AFI panellists have proved cautious over the recent rally in Asian equities and are moving money only gradually into emerging markets as fears of equity bubbles in the region persist.
First State’s Asia Pacific Leaders is the most popular fund in the Aggressive and Balanced AFI portfolios, chosen by eight and nine panellists respectively. Despite its focus on traditionally volatile markets it is also the fourth most picked fund in the Cautious portfolio, with six panellists including it. As a consequence, it is significant for AFI panellists that the group is suggesting a cautious approach to investing in these markets. In fact, the group’s caution in its Global Emerging Markets Outlook for 2011 is slightly understated by Cockerill.
The report states: “Some GEM markets and stocks are now entering bubble territory, perhaps the inevitable result of highly accommodative global monetary policy. Indeed, policy makers appear to be recreating the conditions of 1999 and 2007, which both ended in disaster for equity investors. We can only speculate what the result will be this time but it could be worse than what was experienced in 2000 and 2008.”
Part of the problem highlighted by First State is that monetary policy in developed markets, notably the programme of asset purchases undertaken by central banks in America and Britain, has left a pool of liquidity. While one of the (possibly) intended consequences of this so-called quantitative easing is to reduce the yield on government debt and drive money back into equity markets, many investors have been lured by the potential of greater gains in emerging economies.
These huge inflows help to stoke inflationary pressures and drive up local currencies, a problem that has already been noted by the Brazilian government. They also create an environment where certain asset classes become prone to excessive valuations, which are then vulnerable to sudden market corrections.
Without capital controls being introduced by governments there are few tools available to policymakers to prevent this haemorrhaging of liquidity. What it does indicate, however, is that investors should treat excessive returns in emerging equity markets over the short term with a degree of scepticism.
“If you had a slowdown in China then everyone would feel it,” Cockerill says, “but markets can run on for much longer than logic would dictate. My guess is that we will be in a position where value is much harder to find, but I suspect the upwards trend is likely to continue.”
McDermott points out the foreign exchange benefits of investing in some of these markets. “An allocation to Asian equities not only gives you access to the fastest-growing region of the world but also gives you exposure to local currencies,” he says. “Asian equities don’t look particularly cheap any more but the currency uplift will mean the outlook for the short to medium term is still positive.”
Whatever the case proves, it seems that the structural risks that many economists placed at the core of the financial crisis are still present. Without a more honest discussion of necessary economic rebalancing in sluggish developed economies these risks are more likely to grow than diminish.
The Adviser Fund Index series – a summary
The Adviser Fund Index series comprises an Aggressive, Balanced and Cautious index each tracking the performance of portfolio recommendations from a panel of 18 investment advisers. For each risk profile, all panellists specify a weighted portfolio of up to 10 funds from the authorised UK unit trust and Oeic universe that, when aggregated, define the constituents and weightings of the three AFIs (see www.fundstrategy.co.uk/afi/).