Emerging markets had a tough 2013 and events of the last week have seen them sell off even more. But should investors be cautious about being underweight emerging markets right now?
The MSCI Emerging Markets Index dropped 4.08 per cent during 2013 after investors become worried by the impact of the Federal Reserve’s tapering on these countries and signs of slowing economic growth across the region. Over 2014 so far, the index has shed another 6.42 per cent as currency weakness sharpened.
Fund managers plan to shun emerging markets over the coming months too. The most recent Bank of America Merrill Lynch Fund Manager Survey found that a net 28 per cent of asset allocators say they want to be underweight emerging markets on a 12-month view.
However, others argue that investors who have gone underweight emerging markets should consider increasing their weightings to take advantage of the long-term valuation opportunities that have appeared in the space.
Iveagh chief investment officer Chris Wyllie says: “We’re not going gangbusters on emerging markets but we are saying we don’t think you should be underweight now. If you have been clever or lucky enough to be out or underweight then you should be moving back at least to neutral.”
Wyllie says the economic catalyst for a recovery in emerging markets is not yet present, although “the value is strong” and creating opportunities.
He adds: “With markets at 1.5x price-to-book, pretty much whenever you’ve bought them at that level you’ve made good returns from there.”
The CIO also points out that worries such as the devaluation of some countries’ currencies, fears of a hard landing in China and political events such as elections are “inherent risk factors” in emerging markets but seem to be spooking markets nonetheless.
“From a lot of the narrative, it sounds like this is just starting. I hear a lot of comments like ‘it has a lot worse to get yet’ or ‘it’s only just started’. Actually, this has been going on for three years, nearly four, already,” Wyllie says.
“If you look at the risk factors people are name-checking to justify still selling, even after a very pronounced period of underperformance, we don’t feel there is any fresh information to justify selling out.”
JP Morgan Asset Management global emerging markets strategist George Iwanicki says emerging markets look “tactically oversold” as investors have reacted to the Fed’s tapering as though it were full-scale monetary tightening.
He also argues that the falls in emerging market currencies which has sparked the latest sell-off could actually be a good development over the longer-term.
“As painful as it may be in the short term, it is actually very positive that the brunt of the pain from tapering is being felt through currency adjustments; this is making emerging markets more competitive as a whole,” Iwanicki says.
“Encouragingly, we are seeing central banks responding with orthodox moves like rate hikes; India, Brazil, and even Turkey raised rates. This is a key difference versus the 1990s and should reassure investors’ confidence in emerging markets.”
The strategist notes that the market seem to be concentrating on the problems in Argentina, Venezuela and Ukraine. But while the challenges facing these countries are “significant”, they are not directly relevant for equity investors.
He says: “From a stock investor perspective, we believe the emerging market earnings slowdown is largely cyclical, driven by the emerging market business cycle.
“After a prolonged growth slowdown and currency adjustment, emerging market valuations have fallen to a buy territory: price-to-book below 1.5x, emerging markets are cheap on 10-year price/earnings versus the US and the gap with Europe is rapidly diminishing.”
F&C multi-managers Gary Potter and Rob Burdett have recently started to take another look at emerging markets, and Asia in particular, after being heavily underweight the asset class in 2013.
“We think 2014 will be a transition year for emerging markets,” Potter says.
“Of course it’s hard to look at it as a bloc as you have vastly different circumstances in China to India to Brazil. The QE withdrawal in the US will continue to affect emerging markets to a point but we do think emerging markets have changed significantly for the better since the 1997 Asian crisis and the 1998 Russian crisis.”
Potter and Burdett have started to put small amounts of money back into Asia after seeing the compelling valuations present in the region, but remain underweight. This has been funded by taking profits in the US, following a strong 2013 that saw the S&P 500 rise by 29.93 per cent.
“On a price-to-book basis, some of the cheapest markets are in emerging markets,” Potter says.
“Asia has traded this low only three times in the past 30 or 40 years, I think, and if you buy Asia at this price you are definitely going to make money over the next five to 10 years.”