Emerging markets have the potential to recover this year, even if it isn’t picked up on straight away by the broader market, according to Gary Greenberg (pictured). 
The manager, who runs the five crown-rated Hermes Global Emerging Markets fund, says that now is a difficult time for any investor to become overly excited about emerging markets, but he believes that positive changes could be around the corner.
The divergence between developed and emerging markets has become increasingly noticeable over the last year as a result of collapsing commodity prices and the China slowdown impacting the developing world far more negatively than the West, among other geopolitical and macroeconomic headwinds.
Performance of indices over 1yr
Source: FE Analytics
Despite what emerging markets have had to endure though, Greenberg’s £446m fund has managed to provide top-decile total returns over one, three and five years as well as over three and six months.
He attributes this to the fact that there are a vast amount of all-weather stocks across nearly all emerging markets, and that they can be found through thorough bottom-up stock selection complemented by a top-down macroeconomic view.
“Emerging markets have been in a bear market for about five years and one of the main reasons for this is that margins have been compressing,” Greenberg explained.
“They’ve been compressing because wages have been growing, which isn’t the worst thing in the world but it’s not too good for margins. Commodity prices have been tanking, which again isn’t necessarily terrible but for a lot of companies and countries it has been, and finally because growth has been slow. The demand from the West hasn’t been there.”
One of the effects of this, he says, is that corporate debt across emerging markets has increased and therefore squeezed margins further.
However, the manager says that the process of margin compression is likely to reverse, which could in turn spark a recovery across the unloved region.
“There is the potential for a recovery in emerging markets which I think is going to start this year,” he continued.
“I don’t think the markets will recognise it necessarily this year, but I think emerging markets compared to developed markets will bottom out, so their relative performance could start to improve.”
“I also think the markets will begin to notice in 2017 and then really take notice in 2018. You might say I’m kind of optimistic but what the heck, we’ve had five years of a bear market - it could get better.”
Greenberg points out that margins improve through the slowdown of wage rises, which he says is already occurring across many emerging market regions, and also when productivity outpaces wage growth, which he says is just starting to happen.
Another reason he gives for a potential recovery is if commodities were to bottom out, which he believes is highly possible.
The prices of crude oil, gas, copper and industrial metals have all fallen significantly over the last two years as a result of overproduction, slowing growth and therefore less consumer demand.
Performance of indices over 2yrs
Source: FE Analytics
“If commodity prices actually find a base, companies could cut their excess capacity and therefore supply and demand could equilibrate at some point,” the manager explained.
“I think that process has already started but I don’t think we’re there yet, and I think that over 2016 that process will continue and hurt us, and therefore oil prices will find a bottom, I don’t know where but they will, and they won’t stay there because a lot of capacity is underwater at these levels.”
The third way that Greenberg believes emerging markets could recover is through increased demand for goods, commodities and services from the developed world.
Many investors believe that the consumer sector in the West should strengthen as a result of lower interest rates and collapsing commodity prices leaving people with excess cash to spend. Some people however, including the likes of Tilney Bestinvest’s Gareth Lewis, say that there are other headwinds on the horizon for consumer growth in developed economies, such as an aging population and consumers that are in greater amounts of debt.
“I don’t think demand from the developed world is going to come back strongly, I just don’t expect that,” Greenberg said. “But internal demand from emerging markets could certainly improve, and so I think that not this year but next year and the year after, as China in particular leans towards becoming more of a consumption-led economy, that could underwrite some growth.”
However, the manager says that a consistent stream of negative coverage from the financial press has led to many investors forgetting that there are also a series of potential tailwinds on the horizon for emerging markets.
One such media-generated myth, he says, is that all emerging market economies are commodity-orientated. In fact, according to the manager, 65 per cent of EM benchmarks consist of commodity importers as opposed to exporters.
“Another myth is that the numbers are all fake, he added. “I think that if you do your homework carefully you can get a clear picture of what’s happening in these economies.”
“Anybody who just looks at the GDP number isn’t really doing their homework anyway. If you look at the various indicators of the service sector in China, for instance, then you look at indicators in the industrial sector and you look at its national accounts, you can get a true picture of a complex system, just like any system, and parts of it are thriving and parts of it are suffering.”
“The idea that you can’t trust the numbers is less-than-helpful.”
The manager believes that another factor deterring investors is the belief that the management companies of emerging market firms are low quality.
Despite a large proportion of them perhaps not prioritising environmental, social and corporate governance (ESG), Greenberg says that there are still plenty of high-quality management teams with high ethical standards that are responsible corporate citizens.
“Because of this belief, there is a general paradigm that emerging markets are a trade and not an investment,” he said. “I think commodity markets are a trade and not an investment.”
“If you want to equate emerging markets with commodities you could say they’re a trade and not an investment, but if you really pay attention and find companies that actually represent good investments, and if you’ve got a portfolio of those, you’ve got a fund that’s an investment and not a trade.”
Over Greenberg’s tenure, Hermes Global Emerging Markets has provided a loss of 0.27 per cent, compared to its peer average in the IA Global Emerging Market sector’s loss of 22.73 per cent.
Performance of fund vs sector under Greenberg
Source: FE Analytics
The fund has a clean ongoing charges figure of 1.13 per cent.
