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Three emerging markets Capital Economics expects to surge – and funds backing them

29 February 2016

While emerging market equities have underperformed the developed world since 2011, Capital Economics thinks they could rise 25 per cent by the end of next year and highlights three it expects to do particularly well.

By Gary Jackson,

Editor, FE Trustnet

The MSCI Emerging Markets index could outpace developed market equities and rise by around 25 per cent by the end of 2017, according to market strategists at Capital Economics, although a number of countries are expected to present better opportunities for investors than others.

Emerging markets’ underperformance has been continuing for some years now, owing to factors such as plunging commodity prices and slowing growth in China, while – until recently – developed markets had rallied on the back of the central banks’ quantitative easing programmes and rising investor sentiment.

Since the start of 2011, the MSCI Emerging Markets index has fallen 18.62 per cent in total return terms, while the developed market-focused MSCI World has jumped 51.67 per cent. This 70 percentage point gap between the performance of the two indices has left some wary of buying back into emerging markets, but others are eyeing the asset class as a valuation opportunity.

Performance of indices since 2011

 

Source: FE Analytics

At the moment, there seems to be only limited reasons to be cheerful when it comes to emerging market equities. China remains closely watched for any signs of more economic weakness, there are widespread fears that the People’s Bank of China will devalue the renminbi further and the prices of many key commodities remain depressed.

Capital Economics chief markets economist John Higgins and senior markets economist David Rees say that a repeat of “the halcyon days of the 2003-08 emerging markets boom is unlikely”, given that aggregate emerging market growth of only 4 to 5 per cent looks to be “the new normal” and commodities are probably not returning to their recent highs.

“Nonetheless, we believe that there are reasons to be upbeat on the prospects for emerging market equities, especially given the near-apocalyptic scenario that appears to be priced into the market. Not only do we anticipate a cyclical increase in emerging market economic growth, but we also forecast some rebound in key commodity prices,” they said.

“What’s more, we do not believe that the People’s Bank is about to devalue the renminbi. The upshot is that we forecast the MSCI Emerging Markets Index to rise by about 25 per cent by the end of next year. That said, the better performance is unlikely to be spread evenly and we think stock markets in those countries with better growth prospects, or that will benefit from higher commodity prices, will outperform.”

In the following article, we look at three of the emerging markets that the macroeconomic forecasting consultancy expects to do well over the coming years and reveal the funds with some of the highest exposure to them.

 

Taiwan

Taiwanese equities have performed better than the wider emerging markets index over the past five years, but Higgins and Rees tip it as one of the areas to have a strong run in the coming years, not least because of the recent correction in its stock market.


 

Performance of indices over 5yrs

 

Source: FE Analytics

 

“We think that the prospects for Taiwan’s stock market (along with others in emerging Asia) are bright,” the economists said. “We expect economic growth to accelerate in an environment of ultra-low interest rates and close links to China, whose economy we expect to improve. Valuations are also low.”

Funds with the highest weighting to the country tend to reside within the IA China/Greater China sector, with First State Greater China Growth having the highest at 30.5 per cent. Baillie Gifford Greater China has 28.80 per cent, while Legg Mason Martin Currie GF Greater China and Pictet Greater China follow.

Within the IA Global Emerging Markets sector, JPM Emerging Markets Income has 23.50 per cent. GS GIVI Growth & Emerging Markets Equity Portfolio, JOHCM Global Emerging Markets Opportunities and Charlemagne Magna Emerging Markets Dividend also have 20 per cent or more in Taiwan.

Passive investors will find that there are 10 exchange-traded funds (ETFs) that track the country’s stock market, with the largest being the £2bn iShares MSCI Taiwan Index ETF. DB X-Trackers MSCI Taiwan Index UCITS ETF has the lowest tracking error.

 

Chile

In contrast to Taiwan, the Chilean stock market has significantly underperformed the MSCI Emerging Markets index over the past five years after dropping 35.01 per cent in total return terms. This is in partly down to the country’s reliance on copper exports, as the price of the metal has sank 45 per cent over the same period.

Performance of indices over 5yrs

 

Source: FE Analytics

“Low valuations suggest that equities in Chile will also perform well if, as we expect, the copper price rebounds,” Higgins and Rees said. “The same could be true in other parts of Latin America. Admittedly, the prior falls in commodity prices will take their toll on economies such as Brazil. But markets are forward looking and higher commodity prices could lift equities.”


 

Stewart Investors Latin America has the largest exposure to Chilean equities at 42.20 per cent, while Henderson Gartmore Latin American is next with 30.90 per cent. Other Latin American portfolios have less than 15 per cent in the country.

Out of the global emerging markets funds, Henderson Emerging Markets Opportunities tops the list with an 11.50 per cent allocation. Newton Emerging Income, PFS Somerset Emerging Markets Dividend Growth and PFS Somerset Emerging Markets Small Cap come next, with between 4 and 5 per cent in the country.

There is only one ETF that tracks the Chilean stock market, which is the £181.6m iShares MSCI Chile Capped Investable Market Index fund.

 

India

The Indian stock market has been closely watched over recent years, after the election of pro-business reformist Narendra Modi as prime minister in 2014 sparked a wave of optimism towards the emerging market powerhouse. Over five years it’s up around 3.5 per cent, but has struggled more recently on the back of doubts over Modi’s reforms.

Performance of indices over 5yrs

 

Source: FE Analytics

However, Capital Economics said: “Although we have some reservations about the prospects for structural reform in India and also the quality of the economic data there, reasonably bright growth prospects relative to the other BRIC nations could support equity prices.”

There are 17 funds in the Investment Association universe that specialise in Indian equities. Five of these – Jupiter India, Jupiter India Select, Matthews Asia India, Mirae Asset India Sector Leader Equity and Stewart Investors Indian Subcontinent – are headed by FE Alpha Managers.

In the IA Global Emerging Markets sector, 48 members are overweight the country with Neptune Emerging Markets having the highest allocation at 36.33 per cent, followed by F&C Emerging Markets, Newton Global Emerging Markets and JPM Emerging Markets.

In the ETF space, 15 funds focus on Indian equities with the largest being the £983.6m WisdomTree India Earnings fund. The fund with the lowest tracking error is the iShares S&P India Nifty 50 Index ETF.

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