Further loosening of monetary policy in developed markets and a lack of dependence on the UK means that opportunities have opened up within the emerging market space, according to a number of investment professionals.
Despite the fact that the FTSE 100 is at its highest peak so far this year, many investors remain wary of the market given the uncertainty surrounding the impending Brexit.
Performance of index in 2016
Source: FE Analytics
In an article published days after the ‘leave’ majority vote for Brexit was announced, FxPro’s Simon Smith warned that the FTSE’s strong performance can be attributed to sterling’s weakness as opposed to any strengthening of the UK economy.
“As always, the FTSE 100 acts an illusory indicators of the UK economy. The fact is that it has recovered all of the losses seen in the wake of Brexit. Happy days I hear you say,” he said.
“The fact also remains that it’s, to a fair degree, a measure of how companies are doing that dig lots of stuff out of the ground and sell it in dollars. Oil companies make up three of the top six constituents and they have been flying because of the currency moves, up around 10 per cent since the vote.”
Elsewhere, many investors have become worried about European markets due to heightened political risk and others argue that the US market is mature, expensive and faces its own headwind in the form of the upcoming presidential election.
Given this dynamic, Valentijn van Nieuwenhuijzen, head of multi-asset at NN Investment Partners, says now is the time to focus on bombed-out emerging market equities. Indeed, he is now planning on closing his underweight within the market area.
“We think that the global equity environment is currently very supportive for emerging market assets. News from China is far from great but it’s not as bad as it was at the beginning of the year. The relative risk there has improved because the risk in Europe has increased,” he explained.
“Since the Brexit vote emerging markets have done very well, this is mainly explained by the fact that the risk in Europe has increased a lot while the risks within emerging markets have remained the same.”
Van Nieuwenhuijzen says that India is his preferred emerging market region as it offers strong growth prospects, has no major region-specific headwinds at the moment and has reasonable government policy.
His colleague, senior emerging markets strategist Maarten-Jan Bakkum, adds that emerging markets are particularly attractive given that the continuation of loose monetary policy in developed markets.
"Already in the past weeks, we have seen numerous rate cuts and statements that anticipated rate hikes are off the table. For the emerging economies, this easing of monetary conditions is very welcome to help creating the conditions for a growth recovery,” he said.
“We continue to believe that the structural growth slowdown in China, the high leverage throughout the emerging world and the bleak prospects for global trade growth are likely to prevent a pronounced growth recovery in emerging markets.”
“But with emerging market growth momentum neutral now, which means that EM growth has stopped declining, the chances of a modest pick-up have increased thanks to the recent improvement in EM capital flows and the decline in EM interest rates.”
The MSCI Emerging Markets index has indeed performed strongly year-to-date, outperforming the MSCI AC World and FTSE 100 indices by 4.69 and 12.3 percentage points respectively with a return of 20.35 per cent.
Performance of indices in 2016
Source: FE Analytics
This is a far cry from the index’s performance since the financial crash of 2008 to the end of last year though, when it returned just one-thirteenth of the MSCI AC World’s total return over the same time frame.
Dider Rabattu, head of global equities at Lombard Odier Investment Management, believes that Brexit could mean the start of a multi-year bull run in the market space and says that post-referendum volatility could make for stellar opportunities within emerging markets.
“After almost five years of underperformance and strong currency depreciation, several emerging markets now have high real interest rates compared to developed markets,” he said.
“Brexit is likely to enable emerging market central banks to implement more accommodative policies as inflationary pressures recede further. There will be strong similarities between Brexit and the events of September 2001 in the US in terms of market impact.”
Following the September 11 attacks, the US fell into recession while the performance of emerging market equities rose, beginning their path towards a multi-year bull run.
Performance of indices since September 11 2001 to start of 2008
Source: FE Analytics
Rabattu believes that Brexit could have a similar impact on the market area due to increased pressure on developed markets and the continuation of ultra-loose monetary policy.
“These implications, combined with attractive valuations for EM equities compared to DM equities, have further reinforced our belief in EM equities,” he continued.
“Like in 2001, from a corporate standpoint, returns on equity in DMs are high but are cyclically low in EMs. This spread will likely narrow to the benefit of EM corporates, which, due to depressed relative valuations, now look even more attractive.”
The head of global equities has reduced his developed market exposure over recent months by two-thirds to just 10 per cent. He is simultaneously boosting his direct exposure to emerging market equities and favours markets such as Russia, Brazil and China.
David Jane, multi-asset manager at Miton, points out that emerging markets with low exposure to global trade in particular are likely to remain stable while other markets are impacted by Brexit.
Because of this, he says that there are particularly attractive opportunities in Latin America and Asia at the moment and, more specifically, the domestic-facing stocks in these regions that are due to benefit from rising incomes.
“Looking more widely there are a lot of areas, whose relative merits have been less evident recently, that now come to the fore. Emerging markets amongst international equities, particularly those with a low exposure to global trade, can carry on as before unaffected by Brexit or a slowdown elsewhere,” he said.
“For some time one of our key themes has been the emerging consumer in Asia and Latin America, which given the headwinds for emerging markets, we have been playing through developed markets’ shares.”
“Earlier this year we introduced exposure to emerging markets. We are concentrating on Latin America and Asia with a focus on domestic companies set to benefit from rising incomes rather than global trade and commodities in order to play this theme more directly, now that the headwind has been greatly reduced with a more settled commodity outlook.”
