Issues such as slowing economic growth in China, tightening monetary policy in the US, falling commodity prices and geo-political tensions have all contributed to the poor performance of emerging markets in 2014.
While there was a brief rally following a correction in January, the sell-offs in October and December mean the MSCI Emerging Markets index has returned 2.17 per cent year to date, while the wider MSCI AC World index is up 10.26 per cent.
Performance of indices in 2014
Source: FE Analytics
With the oil price expected to stay at a low level, as the dollar is expected to strengthen over the coming year and as the likelihood of higher interest rates increases, a number of experts have warned that funds within the IMA Global Emerging Markets sector will continue to struggle over the short term.
However, Conway – head of emerging market equities at Schroders – says investors can afford to start turning back to global emerging markets (GEMs).
“Our 2015 outlook for GEMs is constructive but more muted than would otherwise likely be the case in a more ‘normal’ global expansionary phase of the cycle,” Conway (pictured) said.
“We are mindful that the ramifications of a stronger US dollar, a potential tighter financing environment and weak commodity prices could have a negative impact on emerging markets equities.”
“Nevertheless, over 2015 we believe GEMs should deliver reasonable absolute and relative returns compared to developed markets, supported by attractive valuations, strong domestic demand and improving exports.”
Conway is by no-means getting carried away with his own asset class, however.
He points to the possibility of a strong dollar as a major headwind for most emerging markets, as the developing world indices have historically been negatively correlated to the performance of the greenback.
That being said, Conway believes the Federal Reserve’s intention to raise interest rates is now very much known by the market and therefore is likely to have a much smaller impact that the ‘taper tantrum’ – when the central bank warned it was considering stopping its quantitative easing programme – in May 2013.
Performance of indices during the ‘taper tantrum’
Source: FE Analytics
Conway also says that most of the bad news surrounding the developing world is now priced into the market, suggesting that a decent buying opportunity has opened up.
“The year started with an extraordinary level of investor bearishness towards GEMs, as reflected by net outflows of over $40bn from dedicated funds. Since then flows have reversed somewhat but year-to-date there have still been outflows of around $10bn,” Conway said.
“However, significantly, there is a strong case to be made that concerns have already been more than priced in by the market.”
“GEM valuations are attractive with the MSCI Emerging Markets index trading at price-to-earnings (P/E) ratio of around 10.5 times, which is an approximate 10 per cent discount to history and over a 50 per cent discount to the S&P 500 referencing the Shiller P/E ratio – this is the largest discount for over 10 years.”
Dr Mark Mobius, manager of the £1.9bn Templeton Emerging Markets Investment Trust, also bullish from a valuation point of view.
Though he says he doesn’t disregard the concerns surrounding China and Russia – which have the potential to derail emerging market equities even further – he says the index’s extremely low valuations are not justified.
He also says that though the US is tightening its monetary policy, there will be plenty of stimulus sloshing around global markets as both the ECB and the Bank of Japan are expected to ramp up their easing programmes – therefore providing support for developing world equities.
“As of December-end, the favourable trends in emerging markets appeared under-recognised in equity valuations that generally stood well below those of developed markets,” Mobius (pictured) said.
“Even after recent rallies in some emerging markets, they continued to appear relatively attractive to us in relation to history, particularly if very low bond yields and interest rates for savers are taken into account.”
“With our ground-up stock investment research metrics continuing to identify attractive long-term investment opportunities, we remain optimistic about the potential of emerging markets.”
The underperformance of emerging markets, relative to the likes of the US and UK, has been going on for some time now.
According to FE Analytics, the average fund in the IMA Global Emerging Markets sector has returned just 14.17 per cent over five years, while the IMA North America sector and the IMA UK All Companies sector have returned 93.96 per cent and 62.35 per cent, respectively, over that time.
Performance of sectors over 5yrs
Source: FE Analytics
Though they have struggled for such a long time, the likes of FE Alpha Manager Marcus Brookes have warned that there are still too many uncertainties facing global emerging markets funds to justify investment at this point in time.
This is the view held by the large majority of experts and, as a result, Alex Tedder – who also works at Schroders as head of global equities – says investors need to be very selective when it comes to their exposure.
While he is largely avoiding emerging markets within his portfolios, he is very bullish on India – which has already had barnstorming 2014 so far following Narendra Modi’s election victory earlier this year.
Performance of indices in 2014
Source: FE Analytics
Though Indian equities have delivered stellar returns over recent months, he expects more of the same in 2015 and therefore recommends investors target the region for their weighting to emerging markets.
“The emerging markets are a concern and our earnings outlook for three of the four BRICs is negative. India is the only bright spot in our view: it has an exciting investment story, with exceptional demographics and a vibrant private sector,” Tedder said.
“Although the economy and the market have both done well in 2014, we think they have further to go. The new government’s policy initiatives are encouraging and should benefit domestically-orientated companies, particularly those with exposure to fixed capital formation and financial services.”
He added: “The Indian consumer should also receive a welcome boost from lower energy prices and reduced inflationary pressure.”
His thoughts are similar to Ben Gutteridge at Brewin Dolphin, who also expects India to be the leading emerging market next year.
Direct India funds include JPM India, Jupiter India and Invesco India Equity. Emerging market funds which are overweight India relative to the index include Somerset Global Emerging Markets, First State Global Emerging Markets and Skagen Kon Tiki.
Our data shows there are 38 funds in the IMA Asia Pacific ex Japan funds which are overweight India, including the likes of Fidelity Emerging Asia, First State Asia Pacific Leaders and JOHCM Asia ex Japan.
