Emerging markets have underperformed their developed market peers for several years now, leaving investors questioning whether these potentially high-growth areas have now fallen to attractive valuations. 
Emerging markets aren’t to every investor’s taste. Last week, FE Alpha Manager James Thomson (pictured) told FE Trustnet that he has never invested directly in emerging markets because he doesn’t believe that he has the specialist knowledge required.
Would investors be better off casting their fears and doubts aside and putting their cash to work in emerging markets? Not according to Fidelity’s 2015 Global Analyst survey released this week.
The firm’s worldwide survey of 159 equity and fixed income analysts found that companies in developed markets scored much higher on confidence, returns and balance sheet strength.
What’s more, the survey revealed a growing differentiation between different countries within developed markets and found that Japan achieved the highest global sentiment score at 7.1 points, followed by Europe at 5.8 and the US at 5.6.
Global sentiment scores for the Eastern Europe, Middle East and Africa region and Latin America are more negative, however. At just 4.3 points, they are the lowest in the regional rankings.
The lack of confidence in emerging market businesses and general macro concerns such as tighter monetary policy in the US and slowing growth in China have led to investors avoiding emerging markets over recent years.
FE Analytics shows the MSCI Emerging Markets index has risen 12.71 per cent over the past three years and has been significantly outpaced by the 54.72 per cent advance in the developed market-biased MSCI World.
Performance of indices over 3yrs
Source: FE Analytics
A Legg Mason survey this week found that more investors are planning on selling down their exposure to emerging markets than increasing it – 29 per cent of global investors are shifting away from the asset class, compared to 21 per cent allocating to it.
Adam Gent, head of UK sales at Legg Mason Global Asset Management, said: “While valuations could be seen as attractive across the emerging markets space generally, there are still plenty of headwinds to deter investors.”
“The falling oil price, a strengthening dollar and the increasing likelihood of a continued slowdown in China are all weighing on sentiment and causing investors to reassess their current position.”
Legg Mason’s survey, which involved 4,208 investors across 20 markets, also found that 49 per cent of global investors believed Russia to be the biggest investment risk at the moment.
This was more than double China’s total of 23 per cent and far more than Brazil at 27 per cent, despite the South American country having a similar exposure to energy.
Results from the Fidelity survey proved similar, with around 59 per cent of the analysts believing that management confidence had deteriorated significantly among the emerging market companies they cover. In contrast, only 8 per cent believe that this confidence has increased.
However, China didn’t fare too badly, with a third of analysts saying that management confidence in the country has increased. Some 80 per cent of analysts also expect Chinese dividends to be maintained this year.
But while investors remain resolutely downbeat on emerging markets, sentiment towards formerly unloved areas such as Japan and Europe is on the up.
Henk-Jan Rikkerink, head of equity research at Fidelity Worldwide Investment, said: “The key theme of 2015 is divergence. It pays to be selective. The spread of outcomes by region and by sector are probably higher from a fundamental perspective than we expected this time last year.”
He sees the rise in confidence when it comes to Japan as being significant.
“What you’re really seeing here is that Japanese companies are giving Abenomics the benefit of the doubt. There are three key arrows to Abenomics: fiscal, monetary and structural reform, and structural reform is the hardest.”
“That’s the one where, to date, there has been the least progress. However, it’s the one which is very focused on Japanese companies because it’s all about orienting them towards growth. What comes out of it is greater capital efficiency.”
“Seventy-five per cent of our analysts believe this is going to have a positive impact. Specifically they believe it will increase the return in equity of the Japanese-listed sector. If that comes through, of course, there are all the positive valuation benefits that come with that.”
Rikkerink says that one factor driving the equity return increase is the indication that corporate governance is going to improve in Japan. He believes that, while generating a high return on equity hasn’t seemed to be a high priority for the Japanese corporate sector, it is starting to become more common.
“They [Japanese companies] lag against the rest of the world quite significantly in terms of ROE [return on equity] they generate but there’s a real belief that the Japanese CEOs are making a shift and going for this,” he said.
“The key reason why it’s sustainable is because it’s internally driven, so this is a ‘made in Japan’ plan with the Japanese prime minister driving the Japanese corporate sector supporting it.”
Some 75 per cent of the analysts surveyed also believe that dividends will increase in Japan. Rikkerink explains that this is due to a growing preference for capital expenditure growth as opposed to maintenance, which is a sign of belief in businesses from management teams.
He also says points out that Japan is one of the only places where analysts believe wage inflation will pick up, as Japan only has 3.5 per cent unemployment.
“Thinking about this in a different way, if you were going to think of Japan as a stock that you might buy, it’s got improving fundamentals: it has a decent valuation and it’s got good marginal buyers of people wanting to move into that market. So overall the market in terms of its momentum comes out on top,” he continued.
Similarly, Luca Paolini, chief strategist at Pictet Asset Management, continues to see value in European and Japanese stocks and remains overweight in both.
“Japanese stocks retain their appeal, in our view,” he said. “Economic reforms, persistently loose monetary policy, and a weak yen should continue to boost earnings momentum across corporate Japan.”
Like Rikkerink, Paolini sees increasing evidence of an improvement of corporate governance across the country, which he says should result in more shareholder-friendly policies such as dividend increases, share buybacks and growth-boosting acquisitions.
Paolini also agrees with Fidelity’s analysts that Europe is another developed market which is far more desirable than emerging markets.
“The improving macroeconomic backdrop in the single currency region is a major plus,” he explained.
“German retail sales adjusted for inflation rose 5 per cent on the year in January, the highest level in 20 years.”
“The recent wage settlement for metal workers also points to a strong increase in purchasing power for consumers. Moreover, the fall in the value of the euro is serving to boost the competitiveness of companies in southern Europe, particularly exporters based in Spain and Italy, while lending to non-financial corporates has risen.”
Rikkerink says that, at a macro level, there are real signs of business activity picking up in Europe, and of consumer confidence increasing in the region.
“In addition to that, the low oil price environment is positive for the majority of the European-listed corporate sector,” he added.
“Europe is a net importer of oil and oil of course has become cheaper. The majority of the listed sector benefits from this either as a cost reduction because their input costs have gone down or in the consumer sector as they’re spending less of their money on energy.”
“It does take time to feed through – there’s about a six to nine-month lag between the consumer seeing the benefits and starting to spend more. That should come through, especially as we go towards the second half of this year.”
