Leader: Keep calm and carry on with EM holdings

Adam Lewis 160 byline alt

Headlines have not been kind this week to emerging market funds, with investors seemingly losing faith in the region amid increasing fears of a Chinese hard landing.

According to June’s Bank of America Merrill Lynch global fund manager survey, asset allocators’ emerging market holdings hit their lowest level since December 2008 – a “collapse”, the survey called it – as investors took a nine per cent underweight in the region.

To put this into context, just four months ago, a net 43 per cent of the same set of investors were overweight in emerging markets.

To make matters worse, a net 25 per cent of those surveyed said emerging markets was the region they are most likely to underweight in the coming 12 months because they rate a so-called hard landing in China as their biggest fear right now.

These concerns were echoed by statistics published more recently by EPFR Global, which reported that during the week ended 19 June, more than $3bn flowed out of emerging market equity funds worldwide, while outflows from emerging market bond funds hit a 90-week high as the “exodus” – as EPFR Global put it – continues.

“Exodus” and “collapse” in one week. It is hardly a marketing manager’s dream. But those who have not already hit the sell button should wait a moment before doing so. Buried among the bad news was an encouraging report from the usually bearish forecaster Capital Economics.

While admitting the prospect of a tapering of the US central bank’s quantitative easing could continue to bear down on emerging market prices, it predicts that “the worst of the sell-off may soon be over”.

With QE playing a key role in “pushing” capital into emerging markets in the first place, Capital Economics says it is no surprise investors have reacted to the prospect that it is on borrowed time by running for the hills. However, at about four points, it adds that the current price/earnings discount of the MSCI Emerging Markets Asia Index to the MSCI World Index is the largest it has been for more than three years.

“The upshot is that we think the downside for EM equities is now limited,” says Capital Economics’ chief markets economist, John Higgins.

Uh-oh for those who have just run for the hills – and it gets worse. The BofA’s ML survey adds that bearish sentiment towards emerging markets has historically coincided with the outperformance of the region against developed markets.