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Is now finally the time to buy emerging market funds?

09 February 2016

FE Trustnet speaks to a panel of fund managers regarding emerging markets, and whether the current valuations in the sector warrant hunting around for buying opportunities.

By Lauren Mason,

Reporter, FE Trustnet

A day has hardly passed when financial media outlets haven’t mentioned oil or China in regard to market headwinds, and both factors point to problems within emerging markets.

Many investors have been bearish on the asset class as a result of plummeting energy prices and the impact on oil exporters, China’s slowdown and the fact that the Federal Reserve has now begun to raise rates, which will strengthen the US dollar and leave many countries with dollar-denominated debt facing serious challenges.

However, this has led to cheap valuations in the region, with the MSCI Emerging Markets index closely following the pattern of the oil price over the last year and making a total loss of 18.37 per cent.

Performance of indices over 1yr

 

Source: FE Analytics

Should investors be looking to buy into this unloved area of the market at the moment or does it have further to fall?

Of course, there have been plenty of false dawns with emerging market equities over the past five years so is it even worth taking on the higher levels of risk in the first place?

Richard Titherington (pictured), chief investment officer of emerging market and Asia Pacific equities at JP Morgan, thinks so.

“Broadly negative emerging market sentiment continues to reign, but investors may be overlooking an opportunity amidst the bearish environment,” he said.

“Prices have certainly reached extremely attractive levels. As of the end of January, the average P/B ratio on the MSCI Emerging Market index was 1.3x P/B, relative to a long-term historical average of 1.8x P/B.”

“For those investors with adequate risk tolerance and a sufficiently long-term time horizon (three to five years to invest), this is an attractive entry point.”

Nick Peters, portfolio manager on the multi-asset team at Fidelity, believes that the oil price will bottom sooner rather than later, and says this could either happen at the end of this year or as we head into 2017.

This, combined with the fact that his emerging market exposure contributed positively to the Fidelity Multi Asset Strategic fund over the last year, means he has been reducing his underweight in the sector.

“I have been reducing the underweight, but I’m not positive enough to go neutral or overweight just yet,” he explained.

“There will be a time to buy emerging markets because they look cheap. The issue we have at the moment is that returns are falling. The region is trading on a P/B of over 1x, it reached 1x during the financial crisis and even dipped below this during the Asian crisis in the late 1990s so yes they’re cheap, but they could be cheaper and we’re monitoring that very closely.”


Another issue in terms of buying into emerging markets is that many investors have been burned by the sector over the years, and this can increase negative sentiment.

Several years ago, emerging markets proved to be popular because of the high growth prospects, favourable demographics and the fact that the regions were home to a vast majority of the world’s population, yet only accounted for a small percentage of the global market.

However, divergent performances across various developing regions has led to greater volatility and difficulties in recovering from the financial crash of 2008 – the market was then bruised by 2013’s Taper Tantrum when the Fed said it would wind down its quantitative easing programme.

Performance of indices since 2008

 

Source: FE Analytics

Alex Crooke, manager of The Bankers Investment Trust, has significantly reduced his allocation to emerging markets following a negative contribution of 31.2 per cent to the portfolio over the last year.

“The emerging markets space was very difficult, I’ve cut the portfolio very dramatically there so we barely have 1.5 per cent there now,” he said.

“For us, it’s important to point out this is ex Pacific and we’re less bearish than most on China, so we’re looking specifically at the likes of Africa, Latin America, Russia and so on. It’s currencies that are just killing these markets there and we found it very tough.”

The manager says that Latin America in particular was a “nightmare” last year and points out that this is a major reason why the trust is so underweight emerging markets at the moment. However, he says that over a long term view the region could start to look “okay.”

“I think the challenge at the moment is that there are big companies there supporting a lot of debt and I can’t see how you’d get out of that without a debt-for-equity swap. You need some proper capitulation to counter against those levels,” he explained.

“For the governments in these areas it’s very difficult for them – they’ve still got people to employ and taxes to raise, so I think as an investor it’s still very challenging.”

“If you look beyond that on a five-to-10-year view there are resources there, large economies, large amounts of people and money to be made in capital markets. Politics definitely seem to be swinging back towards being more moderate and capital-friendly.”

Simon Evan-Cook, senior investment manager at Premier, has been positive towards emerging markets for a while because of cheap valuations and is now particularly interested in Latin American markets.

“If you’re looking for a macro reason to be bullish on emerging markets there’s the fact that there’s a possibility that US interest rates may not go up at all, or maybe further down the road more QE or stimulus might be administered, which would be quite a relief for emerging markets,” he pointed out.


“That’s are good macro reason for it but we’re not macro investors – it’s the valuations that interest us.”

“The area we’re drawn to as contrarians is Latin America, just because it’s been so out-of-favour and so hated. It’s an area we’re looking at closely although we haven’t made a specific investment there yet. It’s an area we’re continuing to monitor closely to see whether we do come across an opportunity.”

The manager explains that there are no specific regions he is cautious on as valuations look interesting in most areas.

He says the reason he hasn’t gone region-specific when buying into emerging market funds though is that the extreme divergence of EM countries has made certain areas of the market high-risk. As such, he would prefer to allow active emerging market managers to seek out the countries that are beneficiaries of the current circumstances.

One fund he has recently taken a small exposure in is Henderson Emerging Markets Opportunities, which has been run by FE Alpha Manager Glen Finegan, who was formerly at First State, for the last year.

Over this time, the four crown-rated fund has provided a total loss of 13.43 per cent, compared to its peer average and benchmark’s losses of 18.45 and 18.26 per cent respectively.

Performance of fund vs benchmark and sector under Finegan

 

Source: FE Analytics

The manager has a concentrated portfolio of 63 stocks, and currently has his largest regional weighting in the Americas at 24 per cent. This is followed by the Pacific Basin at 19.8 per cent, Asia Pacific at 13.3 per cent and South Africa at 8.4 per cent.

“Finegan used to be a manager at First State – he has got a good reputation and great experience. The fund that he’s running is also of good size, so that’s useful,” Even-Cook said.

The £134m fund has a clean ongoing charges figure of 0.91 per cent.

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