A significant buying opportunity in emerging markets has opened up thanks to signs of economic stability in China, according to Neptune’s Robin Geffen and James Dowey, who argue developing world equities can repeat their mid-2000s outperformance even if the US Federal Reserve continues to raise interest rates.
Though emerging market equities were the mainstay of most growth portfolios prior to and immediately after the global financial crisis, the developing world has become increasingly out of favour over the past six or so years as various headwinds have dogged the asset class.
These include concerns over the future of the Chinese economy, falling commodity prices and a stronger dollar – as well as the expectation of further interest rate rises from the US Federal Reserve (Fed).
Annoyingly for many investors who have deemed emerging market equities to be very cheap, there have been numerous false dawns in the asset class over that time and one of the best examples was during the first few months of 2015.
Indeed, emerging markets were powering ahead of developed world indices until around this time last year with gains of 20 per cent, only for sentiment to swing widely against them for the remainder of 2015 as the Chinese stock market crashed, commodity prices fell again and China devalued its currency – further adding to emerging markets relative underperformance over the medium term.
Relative performance of indices over 6yrs
Source: FE Analytics
That being said, emerging markets have once again come flying back over recent months and Dowey – chief investment officer and chief economist at Neptune – says now is finally the time to be constructive on the developing world.
“So far this year, the biggest development for me has been an improvement in the conditions in China,” Dowey (pictured) said. 
“China was obviously a huge headwind for stock markets last year and that was due to a combination of both economics and politics. China found itself in a position where its currency regime became, all of a sudden, incredibly untenable.”
“They were pegged to the dollar and the dollar strengthened a heck of a lot over 18 months because the US economy was quite strong. That was exported to China and the Chinese economy wasn’t comparatively as strong and couldn’t handle it.”
Dowey says that the Chinese policy makers had a relatively “simple job” on their hands, which was to devalue the currency. However, he says the major cause of strife last year stemmed from the Chinese government’s inability to properly communicate its policy to global markets.
However, as the renminbi has fallen some 5 per cent relative to the dollar over one year, Dowey points out that growth has accelerated and both fiscal and monetary policy are playing a constructive role, which in turn means Chinese policy makers have finally begun to “steady the ship”.
Relative performance of currencies over 1yr
Source: FE Analytics
This has had a profound effect on Geffen’s views on emerging markets in his Neptune Global Alpha, Neptune Global Equity and Neptune Balanced funds.
“It relieves investor risk-off concern,” Geffen (pictured) said. 
“One of the things people tend to ignore about China is that it is a massive energy importer which is a benefit. I’m not saying emerging markets are out of the woods yet, but the biggest emerging market is China and that is where I have reintroduced a weighting as I’m getting more interested and I have a decent weighting in India as well along with a new modest weighting in Russia now.”
This is the first time Geffen, who was a prominent backer of emerging markets during their boom years of the mid-2000s, has upped his exposure to the likes of China and Russia for a number of years.
Indeed, most of Geffen’s long-term outperformance relative to his peers has been down to his positive call on emerging markets during the credit boom years.
Performance of Geffen versus peer group composite since January 2000
Source: FE Analytics
He now holds an average 10 per cent weighting to emerging markets across his three major funds and plans to increase that exposure over the coming few weeks.
“People had completely written off emerging markets but that’s when I think things became interesting. I think the wholesale selling is now over. None of these markets, apart from Brazil, are as bad as people believe they are,” he explained.
“There is so much cynicism, despair and concern built into equity prices in emerging markets which means I don’t think there is going to be another big puke. I think the lower for longer interest rate scenario is helpful in emerging markets too, so I think we may look back at 2016 as a year when people should have been buying emerging markets rather than selling them.”
“You don’t want to put it all in now, but you want to be building positions and looking carefully at valuations. Opportunities are opening up and the stabilisation in China is the bedrock of that.”
Though the consensual view is that emerging markets will struggle to make any real headway in a world where the dollar is still strong, US monetary policy is beginning to tighten and global inflation expectations remain low, Geffen firmly believes they can repeat their stellar mid-2000s outperformance.
Performance of indices between 2002 and 2007
Source: FE Analytics
“From where I see it, emerging markets quite clearly go through cycles. You tend to get five or seven great years and five or seven lean years.”
“We had lean years recently, but emerging markets aren’t going away if you look at them in terms of population and strategic positioning in the world. So my view on that and whether or not they can deliver again, from a market perspective, is absolutely.”
That being said, while many believe emerging market equities are cheap from a historical basis and in relation to the developed world, the major concern is that the US dollar will continue to strengthen as the Fed implements further rates hikes.
This dynamic, according to various industry commentators, will mean there will be limited catalysts for the low valuations on offer in emerging markets to be realised.
However, Dowey questions the widely held view that emerging markets will struggle to outperform in a rising interest rate environment.
“What I would say to that is that I see the turning point in Fed policy as May 2013, not December 2015,” Dowey said.
“We have been dealing with this issue for a few years now and a number of economies have made some very positive adjustments. Some haven’t and they are going through crises right now, but a number have so it’s all about the pace in which the Fed tightens from here.”
“That’s the key question, it’s not simply a question of whether they are tightening policy or not. If you think about the mid-2000s era, the Fed was raising rates during a time that emerging markets was putting in substantial outperformance.”
This is contrary to Dowey’s view on emerging markets at the end of last year. However, the economist says his views have changed as he is now far more dovish on the future of US monetary policy as he believes Janet Yellen, chairperson at the Fed, now has a much closer eye on global economics and market trends than just the US.
In an article later this week, we will take a closer look at the emerging market funds other industry experts are buying in the hope the bombed out sector finally starts to turn around.
