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Emerging markets are at the perfect entry point, says S&W’s McGrath

09 June 2014

Smith & Williamson’s Richard McGrath says the next 12 months will see a strong re-rating in emerging markets.

By Daniel Lanyon,

Reporter, FE Trustnet

Investors should buy into emerging markets now as they have reached an inflection point, according to Smith & Williamson’s Richard McGrath.

The period of falling markets amid central bank, currency, and political fears have bottomed-out, according to the manager, who says that inflows are rising and valuations have bottomed out.

“We have already seen indications that net outflows are reducing from emerging markets,” he said.

“Over the last five or six weeks there have been net inflows, so we are already starting to see the tide turn a bit in emerging markets despite the negativity that has been thrown at them in the first quarter of 2014.”

“Despite all of the unrest in places such as Turkey, Brazil, and Russia/Ukraine - emerging markets have performed in line with developed markets this year.”

“This indicates that valuations have reached a level where all the selling-off has been done.”

“This is an inflection point providing a very good entry point into the asset class.”

Emerging markets have steadily underperformed developed markets over the past few years.

Fears of rising interest rates in the US and an end of quantitative easing, coupled with a slowdown in China, have been widely seen as the main drivers behind a severe sell-off of emerging market assets since May 2013.

Performance of indices over 2yrs


Source: FE Analytics

The MSCI Emerging Market index has lost 8.69 per cent since mid-May 2013, FE Analytics shows, with the majority of funds in the IMA Global Emerging Markets sector losing more than this over the period and all funds making an overall loss.

Emerging markets have been a lot stronger in 2014 and have outperformed developed markets over the past three months, unaffected by the April market correction that saw double digits wiped off the share price of developed market technology and biotechnology stocks.

The MSCI Emerging Markets index has risen faster than developed markets over this period, rising 7.98 per cent, whereas the S&P 500, FTSE All Share and MSCI Europe all rose less than 4 per cent over the same period.

Performance of indices over 3 months

Source: FE Analytics

McGrath says the underperformance of the asset class was partly caused by push factors such as tapering and currency fears but also due to developed market equities being generally more in favour with investors, particularly in the US as they gained traction in the recovery from the financial crisis.

“However, as that momentum slows in the US and Europe investors will start to re-look at emerging markets,” he said.

“Over the next six to 12 months the inflows into active managers will increase significantly, boosting markets.”

“There is the potential to make a 50 per cent return over the next 18 months. My longer run aim is to make a 10 per cent annual return for the fund after this.”

He says he expects some of this to come from as value strategy but also due to a growth in payment of dividends by Asian companies who had previously not been regular payers of dividends.

McGrath manages the recently launched Smith & Williamson Emerging Markets Value fund, which will seek to achieve long term capital growth together with some income, investing in between 50 and 90 stocks with market capitalisations of at least $500m.

The fund will take ac country specific view as well as a stock specific view, McGrath says.

“On a geographic basis political risk is something we will very seriously. We currently have ruled out investing in Argentina, Venezuelan and Egypt because of this. We’re seeing a lot of value in Brazil, Mexico, China, and Korea.”

“However, where we believe the risk to be short term such as in Russia and Turkey, we use it as a short term entry opportunity.”

“We are overweight in Turkey and neutral on Russia, but we think it is a cheap market.”

McGrath says he recently sold out of an overweight position in India, despite a positive outlook for the country.

“We were heavily exposed to India but have taken profits recently due to better opportunities elsewhere and the fact our holdings had doubled in value.”

“I'm positive on the outlook for India as the result of the national elections was a strong signal that the populace want reform and the removal of the structural barriers that are holding its economy back.”

“However, when my share prices double I take some money off the table. We are still reasonably exposed to India but my experience of emerging markets is that when you make gains you have to lock away the profits otherwise someone will take them for you.”

He says the fund will avoid the use of exchange traded funds (ETFs) despite holding several at the launch of the fund.

However, he adds their recently upsurge in popularity would help rather hinder the performance of the fund.

“It will drive inefficiencies in the market that we able to exploit,” he said.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.