With emerging markets in the doldrums, is it time to buy?

Paul Broadhead

The hot money which has flowed into the stockmarkets of the world’s emerging economies has of late been dogged by underperformance relative to developed nations.

Investors in their droves poured cash into emerging markets over recent years in a bid to find a better return than that offered by the sluggish economies of the developed world.

But the worm has turned and many investors, after suffering corrosive losses, have been reminded about the inherent risks and volatility associated with investing in developing nations.

Concerns over China’s slowing economy and the timetable for the US’ plans to ease back and ultimately pull its stimulus measures have spooked markets and global emerging markets have been hit worse than most.

Schroders chief economist Keith Wade says: “The US Federal Reserve has signaled that interest rates are eventually going to begin to rise and QE will end, so we have seen a rise in bond yields in the US. This means that liquidity flows into emerging markets are reversing, squeezing liquidity in these markets.”

Keith Wade 190
Keith Wade

Notably, emerging market specialist Aberdeen Asset Management reported a net outflow of £3.4bn in the three months to the end of June in its quarterly results this week. Within this almost £1bn, more than 26 per cent of the redemptions, were haemorrhaged from emerging market equity strategies.

In the 12 months to the end of June 2010, the MSCI Emerging Markets index delivered a considerable 36 per cent growth, more than comfortably outpacing the FSTE All-Share’s 21 per cent and the S&P 500’s 26 per cent.

But since then it has generally been a case of diminishing returns, with growth collapsing over the following two years. In the past year, the MSCI Emerging Markets index has achieved a total return of 7 per cent, while the US’s S&P 500 has achieved 25 per cent and the FTSE All-Share has returned 18 per cent.

But while many would argue that the easy money has been made from countries such as China and India, some commentators are questioning whether the fall from grace represents a buying opportunity.

Legal & General Investment Management global equity strategist Lars Kreckel says: “Emerging market equities have been the biggest laggards and unlike Europe and the US, the underperformance has also resulted in a sharp de-rating.

“On a price to book basis the 20 per cent premium emerging market equities traded on in 2010 has turned into a discount of the same magnitude. Given that we continue to believe in the long-term prospects of the region, the valuation discount suggests this is an attractive opportunity for long-term investors.”

M&G Global Emerging Markets fund manager Matthew Vaight believes that following the recent market falls, “the valuations of emerging market equities are now compelling”.

He says: “On a price-to-book ratio, emerging market equities are currently trading around their lowest level for many years and are cheaper than developed market shares by some 25 per cent.”

Matthew-Vaight-MG-700x450.jpg
Matthew Vaight

But valuation tends to be a poor guide to short-term performance says Kreckel, noting that LGIM’s current stance is that it is too late to sell but too early to buy given the risks surrounding the slowdown in China.

He adds: “There are two things that would make us turn more bullish from a tactical perspective.

”Firstly, signs of investor capitulation, for example a valuations overshoot or excessively bearish positioning data. Alternatively, evidence of a macro catalyst that reduces the tail risk of a hard landing, such as improving growth data or policy measures which support growth, may improve our tactical outlook.”

But the low valuations are, in Vaight’s view at least, a clear sign that stockmarkets are presently being influenced by sentiment and macroeconomic concerns such as weaker economic growth and softening commodity prices rather than trading on fundamentals.

Although emerging market companies on the whole generate a higher return on equity, and are thus more profitable than their counterparts in developed markets, they are now trading at a significant discount to Western companies he says.

Vaight adds: “While the falls in emerging market share prices may be justified by the decline in corporate performance, the magnitude of the sell-off is arguably too great.”

Chase de Vere head of communications Patrick Connolly asserts that potentially any sector getting battered is arguably an investment opportunity. He says: “Markets overreact; they rise too far during the good times and fall too steeply when the environment turns negative. The issue however is that we do not know how much further underperformance is on the horizon.

“The sensible thing to do right now is to drip feed cash into emerging markets as opposed to investing a lump sum. But when we come to rebalancing our portfolios, we will take take profits from the sectors that have done well and invest in the sectors, including emerging markets that have underperformed.”

Hargreaves Lansdown senior investment manager Adrian Lowcock adds: “Emerging markets are a long-term investment and require investors to have a lot of patience.

”The region is typically more volatile than other stockmarkets as investors sell out when they become more cautious. The key to emerging markets, as with any investment, is to protect your money when markets fall and therefore be in a stronger position as markets recover.”

But right now, Lowcock suggests that investors hold no more than 20 per cent in funds or companies exposed to developing markets.

As for the funds Lowcock and Connolly rate, the £1bn JPMorgan Emerging Markets fund is up there, while Connolly also tips the £559m Schroder Global Emerging Markets portfolio. Lowcock also cites the £260m Newton Emerging Income Fund, which launched in October last year, as one of his top picks.