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When will be the time to buy Asia and emerging market funds?

28 November 2015

Asia and emerging markets have been a perennial source of bad news for investors for a number of years now, but when should they look to buy back into the bombed-out asset class?

By Alex Paget,

News Editor, FE Trustnet

There is always the concern, in investment, that you may end up ‘catching a falling knife’ – which basically translates into buying into an already hated area you think must turn around at some stage, only for it to lose even more money.

This adequately sums up the feeling towards emerging markets and Asia funds at the moment, as after nearly 10 years of unrivalled dominance in fund management terms, developing world equities have had a torrid time of it over the past half a decade or so.

Issues such as slowing growth levels (particularly in China), the end of the commodity super-cycle which has led to a huge fall in the price of most basic materials, geo-political tensions, currency weakness and the prospect of higher interest rates in the US have forced most to give up with emerging market equities.

However, possibly the most frustrating part of it all for investors is that there have been a number of false dawns in the asset class.

In 2012, they rebounded after double-digit losses the year before, only for those gains to be wiped away by the aftermath of the so-called ‘taper tantrum’ in May 2013 when the US Federal Reserve first hinted it would end quantitative easing.

This year is probably an even better example, as during the first few months of 2015 emerging markets were flying ahead of developed markets meaning many thought the bear market was over. Between April and August, though, the index fell 30 per cent.

All told, it means the MSCI Asia Pacific ex Japan index has made just 11.38 per cent over five years while the MSCI Emerging Markets index has lost 9.44 per cent. The developed MSCI World index has made more than 60 per cent over that time, as a point of comparison.

The graph below shows just how far emerging markets have fallen out of favour, on a relative basis, over that time.

Relative performance of indices over 7yrs

 

Source: FE Analytics

Nicholas Beecroft, portfolio specialist on the T. Rowe Price Asia ex Japan fund, admits it has been an incredibly difficult time to be in emerging markets.

“You’ve had four or five years of economic slowdown in Asia and in emerging markets more broadly, you’ve had four or five years of disappointing earnings growth and you’ve had four or five years of equity market underperformance compared to developed markets,” Beecroft said.

“Sentiment was very low and people were already thinking, ‘something has to change’. Then, of course, you had Chinese intervention into their stock market, you had the surprise devaluation of the yuan, you’ve had everything that is going on in Brazil (while not an impact on Asia, just for emerging market sentiment more broadly) and I think people just decided ‘enough is enough, throw in the towel’.”

He added: “The third quarter of 2015 was the worst quarter ever for outflows at an industry level. We have seen more outflows from Asia ex Japan and emerging markets funds from an industry in 2015 year to date than we saw in the whole of 2008.”


 

Of course, cheap assets can always become cheaper and with so many apparent headwinds facing the emerging markets and Asia, there is still genuine concerns that the recent snap rally is the calm before yet another storm.

Beecroft thinks this year’s events have opened a buying opportunity, though.

Performance of indices in 2015

 

Source: FE Analytics

“People really are capitulating – which is a good sign for a contrarian investor. In our portfolio, we have been topping up our favourite names during that weakness and force-selling. It was a great opportunity,” he said.

Of course, Beecroft is not alone. The likes of Chris Metcalfe at IBOSS told FE Trustnet earlier this week that enough is enough and therefore now is the time to buy back in.

“Overall, we think the valuations are much better than they have been and so for all the places you want to be active at the moment, this is it. We can’t just go sit here and keep waiting, so we want to bring a third fund in,” Metcalfe (pictured) said.

That being said, there many who aren’t so happy and think more pain is yet to come.

Certainly, there are still fears of an Asian financial crisis take two, a hard-landing in the Chinese economy, the prospect of low commodity prices for a long time to come and the increasing likelihood of higher interest rates in the US, which may hurt many emerging economies with high levels of dollar denominated debt.

Beecroft added: “That China fear reached extreme levels in August, particularly outside of Asia. People were suddenly saying ‘I just don’t understand this anymore, I feel really bad about this, I’m worried the whole thing is going to come crashing down’.”

“Of course, it hasn’t come crashing down. People have started to get a little more comfortable again in the idea that the authorities are managing a slowdown and they have a lot of tools at their disposal.”

“That kind of imminent China crash risk has lifted – for the time being, it doesn’t mean it won’t come back.”

So when will be a good time to buy into the hated asset class?

Beecroft firmly believes that given the valuations now on offer, the fact that so many have left the market and as there are signs that company management teams are getting their houses in order by reducing capex and focusing on delivering value to shareholders, the medium and even short term is bright for Asia funds.


 

He expects Asian and emerging market equities to outperform developed markets over the next five years, but he also expects them to deliver positive returns next year.

However, he thinks the opportune entry point will be after the US Federal Reserve raises interest rates in December.

“Our view is that, although we may see some downside volatility around that, everyone will probably breathe a sigh of relief afterwards as the overhang is removed,” he said.

“As long as the path of those hikes over the next two or three years is a fairly shallow, steady, predictable one, Asia should be fine. The risk, of course, is that they have to tighten more aggressively but that doesn’t seem to be the consensus.”

After that, he thinks perceptions will start to change drastically.

“Over the last few months there has been lots of commentary about a new Asian financial crisis and too much debt in the region.”

Performance of sectors and index during the Asian Financial crisis

 

Source: FE Analytics

“Asia is already five years into a slowdown, we are at least two years into an adjustment phase where currencies have already come off a long way, countries have closed their current account deficits, inflation is really low and yes there is debt but (particularly in China) it is domestically owned and they have control over the financial system.”

“Our hope is that as we move into 2016 and we get the Fed rate hike overhang out of the way, we start to see some better economic and earnings growth coming out of Asia and that will start to drive stock prices again.”

He added: “Instead of markets being very driven by Fed policy or Chinese monetary policy and these big sentiment driven swings.”

 

In an article next week, FE Trustnet will look at the funds which have historically taken full advantage of a recovery in emerging markets. 

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