Emerging market equities have become unloved in recent months as investors belatedly react to three years that have seen the asset class make losses. However, current valuations represent extremes last seen in the depths of the financial crisis, Tepes (pictured) warns, which could be a strong signal that the period of relative underperformance is due to end.
"While in January 2011 emerging market equities were trading at a 10 per cent premium to developed market equities on a P/B [price to book] basis, they are now trading at a 28 per cent discount," she said.
"The current level is even wider than the 15 per cent discount recorded in Q4/2008, which was then followed by about 70 per cent outperformance over the next two years. The relative P/E [price to earnings] valuation is also close to historic lows."
The discount figure is 34 per cent on a price/earnings basis, she notes.
Data from FE Analytics shows that the current poor run for emerging markets shares started in January 2011.
Since then the FTSE All World Emerging Markets index has lost 6.41 per cent while the FTSE All World Developed Market index has made 34.98 per cent.
Relative performance of indices over 3yrs
Source: FE Analytics
Tepes notes that emerging market equities were trading on a 10 per cent premium just as their poor run continued, further evidence that relative valuations are a good guide to future performance.
The analyst says that the three trusts she would expect to do best in a rising market are Templeton Emerging Markets, JP Morgan Emerging Markets and Genesis Emerging Market, all of which are trading on a discount wider than their one-year average, possibly suggesting an attractive entry point.
Data from the AIC shows that JP Morgan Emerging Markets is on the widest discount, trading on a price 12.48 per cent lower than NAV. This compares with a one-year average of -10.21 per cent and a three-year average of -9.21 per cent.
Despite a widening discount, the trust has held up better than the index on a relative basis over the past three years, returning 8.5 per cent against the MSCI Emerging Markets index’s returns of 3.78 per cent.
Performance of fund vs index over 3yrs
Source: FE Analytics
Templeton Emerging Markets is trading on a discount of 8.76 per cent, but this is much closer to its one-year average of 8.74 per cent; over three years the figure averages out to 7.46 per cent.
Genesis Emerging Markets is on the widest margin to historic average at a discount of 8.09 per cent to NAV, compared with a one-year figure of 4.29 per cent and a three-year figure of 6 per cent.
The trust is also the best performing in recent years, returning 9.31 per cent in share price terms. Templeton Emerging Markets has made 4.73 per cent.
Tepes’ bullishness mirrors the conclusions of George Iwanicki, macro strategist at JP Morgan.
In a recent article, FE Trustnet reported his view that the sector’s valuation is at a level low enough to represent an attractive long-term entry point, particularly in the BRICs.
FE Alpha Manager Anthony Eaton added his voice to those arguing that the downturn in the region was ending last week, suggesting that outflows had peaked and money should soon start coming in again.
However, there is a school of thought that a sea-change is taking place in the relationship between developed and developing markets.
Jonathan Asante (pictured), head of emerging market equities at First State, is more bearish is his outlook for his region, and is shifting his funds towards companies listed in the developed world that sell into the developing world.
"We believe that the global emerging markets index is once again becoming discredited as an investment concept which might make investing in emerging markets through developed world companies more fashionable in the coming years," he said in a recent note to investors. "A recent trip to the Mid-West of America underlined that the pricing power we seek in companies comes from ownership of genuine intellectual property which is mostly found in the developed world."
"Most companies we met in the US had been selling their products and services in the developing world for many decades. Sadly the best companies were often fully priced in the US as well as emerging markets."
Asante also warns that the future direction for markets is far from clear given the uncertainty surrounding economic policy. "We believe that a particular risk for the world economy is the present policies of central banks. Increasingly erratic policy (are they removing money printing or adding more?) gives us real cause for concern on a three-year view."