The asset class sold off in May as the Fed announced it was thinking of withdrawing from its quantitative easing programme. This followed three years in which it had underperformed the developed world.
Relative performance of indices over 3yrs
Source: FE Analytics
However, the difficulties of market timing are well known – selling something that has just done badly could easily see you miss out as it rebounds.
Here, a number of well-regarded managers – some with a multi-asset or multi-region remit – give their chief reasons why they are buying emerging equities now.
Economic recovery will trickle down
Pat Ryan (pictured), manager of the £321m Lazard Global Equity Income fund, says that the recovery in the developed world will feed through into the emerging markets next year.
“The global economic recovery that started with the improvement of the US housing market roughly 18 months ago has now broadened, with Europe recently emerging from recession and Chinese growth showing signs of stabilisation,” he said. “This synchronised recovery is a clear positive for equity markets globally and it has led investors to begin to return to equity markets after consistent outflows since the financial crisis.”
“Emerging market equities have the most to gain from this recovery as they possess the lowest valuations globally and companies are often export-oriented with substantial operating leverage.”
Ryan has been increasing his weighting to Asian and European emerging equities since the summer sell-off.
Valuations are low
Timothy Hay, lead manager of the £62m Somerset Emerging Markets Small Cap fund, is cautious on the outlook for the asset class overall.
However, he says that the low valuations have uncovered some areas of opportunity, but warns that it is necessary to proceed with care.
“Emerging and frontier markets currently trade at a substantial discount to developed markets, with the MSCI Emerging Markets index trading on 11.7 times P/E [price/earnings] and the MSCI Frontier Markets index on 12.4 times P/E, versus the S&P 500 on 17 times and the MSCI World index on 18.5 times.”
“Emerging market [EM] currencies had a terrible 2013 in many cases (Brazilian real, Indian rupee, Indonesian rupiah, South African rand and Turkish lira) and the market seems to have turned against EMs with the belief that they have been on a classic EM debt binge at the consumer and government level.”
“It is in this negative environment that we are able to identify pockets of interest. Many large cap names trade on single-digit multiples and domestic China still throws up some interesting ideas, although we remain cautious on the standards of corporate governance.”
Frontier markets have soared ahead of emerging markets this year and Hay thinks there is still scope for gains here in certain sectors.
Performance of indices in 2013
Source: FE Analytics
“We continue to see interesting ideas in frontier markets, although we caution that the consumer staples sector seems fully valued here and in emerging markets,” he said.
Earnings growth is coming through
Austin Forey, manager of the £1.7bn JPM Emerging Markets fund and £652m JPM Emerging Markets Trust, says that earnings growth is likely to resume next year.
“The single strongest reason for buying EM at these levels is the resumption of earnings growth coupled with attractive valuations,” he said.
Forey points out that valuations are now cheap on both relative and absolute terms, meaning that the markets are undervalued compared with developed countries.
Despite recent struggles, emerging market profitability remains globally competitive, he adds.
Economic fundamentals are solid
Allan Conway, head of emerging markets at Schroders, points out that while equity markets have been weak, economic fundamentals favour the sector.
“It is worth reiterating that EM economic fundamentals are very solid,” he said. “In aggregate, current accounts are in surplus, debt levels are modest and external debt is low.”
“This is in stark contrast to the developed world which is still going through a prolonged period of debt deleveraging.”
“An expanding emerging market middle class continues to drive strong consumption, and fixed capital investment is growing due to the still low levels of capital stock per capita. So in our opinion, the structural story remains intact.”
Politics is improving
David Hoffman, managing director at Legg Mason subsidiary Brandywine, says that governments are getting a grip on their problems.
Perceived political weakness in India was a major contributor to that country’s poor year, while investors have also worried about a number of countries in need of political reform.
Performance of indices in 2013
Source: FE Analytics
“Essentially, emerging markets governments are making politically difficult decisions to improve efficiency and stability – that’s a positive step,” he said. “We will likely be adding incrementally to select emerging markets exposure in 2014.”
“Mexican fundamentals are stronger today than ever following tax, education, and pending energy reform,” he added.
“Countries like Indonesia and India are cutting fuel subsidies.”
“Emerging markets will face some growth challenges in 2014, but we believe much of the recent volatility represents a liquidity issue, not a solvency issue,” he said.
“Select countries look attractive today and delayed tapering gives the universe a little more room to implement structural reform.
