With emerging market funds significantly underperforming their developed market peers over this period thanks to several sell-offs, retail investors’ bearishness is understandable. A broadly accepted slowdown in the Chinese economy, as well as in other emerging markets, after a decade of strong growth is also part of the reason why sentiment has ebbed away.
Performance of sectors over 2yrs
Source: FE Analytics
But with a wide universe for investments within emerging markets, several funds have seen a barnstorming year thanks to 2014’s best performing market, India, with 80 per cent outperforming the FTSE All Share last year.
For example, the likes of Templeton Emerging Markets Smaller Companies, managed by Mark Mobius, returned almost 20 per cent over the course of 2014 while Newton Global Emerging Markets made 12.86 per cent. Both have an overweight to Indian equities.
Performance of funds, sector and index in 2014
Source: FE Analytics
As Jan Dehn, head of research at Ashmore, notes, valuations are now low with a cautious outlook reflected in prices for both emerging market bonds and equities.
“EM [emerging markets] offers pretty good value at the moment. Valuations are attractive as [are] technicals and there is the advantage to a cautious sentiment in that it is not overbought so you are definitely not buying a bubble. It is not something you can say about some European assets, for example,” he said.
Investors started to jettison emerging market holdings in June 2013 as talk of QE tapering abounded, opening up concerns about currency weakness and the so-called fragile five of Brazil, India, South Africa, Indonesia and Turkey’s lurking current account deficits.
As the market has become increasingly focused toward the Federal Reserve’s first rate rise after more than five years of ultra-low interest rates, the impact on emerging markets has been more implicit to many managers and investors.
However, Dehn says there is little that can blow EM off course this year with sentiment already low.
“The Fed is not in a great hurry to raise interest rates because there is no inflation expected until late 2016 in the US. These fears seem rather overdone. There is nothing that the Fed will do this year that will hurt emerging markets,” he explained.
“It is much more likely that that developed markets will see a year of reckoning. They have squandered the past seven years of hyper-easy monetary policy without doing anything about deleveraging or structural reforms.”
Luca Paolini, chief strategist at Pictet Asset Management, is also bullish on emerging markets but says certain key markets will remain pariah investments.
“Economic momentum is generally positive in emerging markets, thanks to weak currencies, a decline in oil prices and a pick-up in external demand. Chinese economic momentum remains weak, but should recover next year thanks mainly to accommodative central bank policies and an improving property market,” he said.
“The picture is less favourable in other emerging markets and is particularly bleak in Russia and energy-related economies. The prospect of a credit crunch in Russia in 2015 is a risk as international sanctions are restricting Russian companies’ access to global capital markets.”
“We would not say that the risk of a 1998-style default in Russia is high, however, as the country has become a significant net creditor to the world.”
Russia’s confrontation with the Ukraine and its loss of return from its oil wealth throughout 2014 has caused its markets to see heavy losses, with some effect of the falls noticeable in the MSCI Emerging Markets index.
Performance of indices over six months
Source: FE Analytics
John Lo, portfolio manager of Fidelity Asian Values, considers the impact of the lower oil price to be beneficial.
“The polarisation of performance between markets which are net importers of oil and those which are net exporters is likely to continue,” he said.
“A strong preference for investing in emerging markets which are reforming to develop stronger domestic demand and which have a tailwind from weaker commodity prices. Generally Asian emerging markets such as China, India and Indonesia fall into this category.”
However, he adds: “It’s not all good news, as this could result in increased volatility and geopolitical risk.”
Dehn agrees and says geo-political risk is the main culprit to scupper returns over the next 12 months in emerging markets.
“Geo-politics is going to continue to be a negative force this year in our markets, certainly for EM,” he warned.
“We will more see more nationalism and foreign policy activity this year. Day by day we can how religion is being brought more and more into the political spectrum. ‘Christianity versus Islam’ almost seems to have supplanted the traditional ‘left versus right’ debate. This will be exploited by politicians.”