Now is the time to buy emerging markets but investors should avoid most developed regions due to economic and political headwinds, according to the BlackRock Investment Institute, the think tank behind the world’s largest asset management firm. 
It’s been an eventful first half to the year, with the EU referendum, US politics and high valuations causing volatility and instability in the market.
However, with Brexit now a reality, the US presidential election just a matter of months away and valuations now even higher following a snap rally in nearly all asset classes over the past few months, the final six months of the year are likely to be just as hard to navigate.
With this in mind, in its mid-year report the BlackRock Investment highlights the equity regions it believes offer the best opportunities for investors and the areas they should attempt to steer clear of to protect their portfolios.
Emerging markets – Positive
While many investors will likely be put off by investing into markets that have perennially underperformed over the last five years, the BlackRock Investment Institute says now could be the time to take another look at the developing world.
“Our conviction is growing. Currencies and trade balances have adjusted, and we see less risk of a sharp U.S. dollar rise,” the report said.
Cyclical challenges have led to poor emerging market returns in recent years, including the falling commodity prices, China’s slowing economy and a stronger US dollars.
Performance of the MCSI Emerging market vs MSCI World
Source: FE Analytics
This has led to serious underperformance of the MSCI World over the last five years, as shown by the graph above. According to FE data, the MSCI Emerging Markets index has lagged the developed market index by some 70 percentage points over that time.
However, year-to-date emerging markets are 5 percentage points ahead of the global index.
BlackRock’s report says this reversal in fortunes is because the previous challenges mentioned above have stabilised and are now reversing, adding that weaker currencies are leading to improving trade balances.
“In equities, we like India on improving economic and reform momentum, and Southeast Asian countries with domestically led growth.”
A number of industry experts are also upping their exposure to emerging markets thanks to a more positive backdrop. Therefore, in an upcoming article, FE Trustnet will take a closer look at a selection of the best-rated funds in the space.
UK – Neutral
Closer to home, however, the BlackRock Investment Institute says it is cautious on UK domestic stocks, warning that recessions for both the UK and Europe could be just around the corner following the historic EU referendum result.
“We believe the UK’s divorce from the EU will be a long and messy process,” it said.
While there is little historic correlation between economic and stock market performance, there are a number of highly-rated UK equity funds for those investors who are feeling cautious on the domestic market.
One example is the five crown-rated Trojan Income fund, which is run by FE Alpha Manager Francis Brooke.
“As a strategy providing a reliable and growing income stream, and exposure to UK equities through a more sheltered return profile, there are few peers that can match [Trojan Income],” Square Mile, the investment research house, said.
FE data shows it has been a top decile performer in the IA UK Equity Income sector over five years with returns of 76.77 per cent, nearly doubling the FTSE All Share’s gains in the process.
Performance of fund versus sector and index overt 5yrs
Source: FE Analytics
The £2.7bn fund has also been a top decile performer for maximum drawdown, annualised volatility and risk-adjusted returns (as measured by its Sharpe ratio) over the last half a decade.
Trojan Income, which yields 3.44 per cent and has grown its dividend in every year since launch, is more international-facing than many of its peers and therefore could benefit from a weaker pound. The likes of Unilever, Imperial Brands and GlaxoSmithKline feature in its top 10, for example.
Meanwhile, BlackRock has a similar stance on the US as it does to the UK.
Though the world’s largest economy faces headwinds rising wages and toppy equity valuations, the report notes the outlook for consumption and labour markets is fairly positive.
The report suggests investors look at funds which own a large number of quality stocks to add to their portfolio if they want US exposure.
Europe – Negative
While BlackRock remains neutral on the UK, it is troubled by the outlook for the Eurozone, where it recommends an underweight position.
“[We] expect downgrades to an already poor growth outlook in the Eurozone as the Brexit vote weighs on sentiment,” it said.
“Europe ECB stimulus is supportive, but post-Brexit uncertainty challenges already poor profits.”
Nigel Bolton — chief investment officer at BlackRock, added: “European equities are now very dependent on economic and earnings growth —which we have yet to see.”
With such low sentiment toward the region, rather than Europe-centric funds, one potential option for those wanting a diversified portfolio could be to invest in a global fund with limited exposure to European equities.
Global funds with the lowest weighting to European equities
Source: FE Analytics
As the table above shows, some of the funds that fit this criteria include Investec Global Special Situations, Neptune Global Equity and SVM World Equity (which have a combined average weighting of just 2.4 per cent).
Japan – Negative
Another area of the world to avoid is Japan, BlackRock’s analysts say, where a “soft economy and rising yen” are causes for concern.
This is not a new problem for the region, which has been a disappointment to investors for a long time as the below graph indicates.
Performance of indices over 10yrs
Source: FE Analytics
Despite certain rallies over recent years thanks to prime minister Shinzo Abe’s reforms and substantial quantitative easing from the Bank of Japan [BoJ], the region has largely lagged other developed markets as investors have remained unconvinced that the authorities can generate inflation and tackle long-standing issues such as an ageing population.
Indeed, the report warns the Bank of Japan is nearing the limits of monetary policy, meaning a further structural reform will be needed at some point.
Andrew Edwards, chief executive officer at ETX Capital, agrees with this.
“The BoJ is nearly out of options – a rally for the yen over recent months has erased all its losses against the dollar since the launch of ‘Abenomics’. Negative rates have been tested and now the BoJ owns practically every scrap of Japanese government paper,” Edwards said.
“Returns on easy monetary policy are diminishing, which may make it do or die time for the central bank as it seeks to inject life into the economy and drag inflation up.”
