Emerging market investors have had a tough time of late, with the asset class taking the brunt of the sell-off in equities back in May and June.
From the market highs on 22 May until the bottom of the most recent correction in mid-June, the FTSE All Share shed nearly 10 percentage points off its value – the definition of a market correction.
However the MSCI Emerging Markets index lost nearly 16 per cent, causing many investors to pull out their cash in favour of ‘safer’ developed market equities.
Emerging markets have since rebounded, but remain significantly behind their developed market rivals so far this year.
Performance of indices in 2013
Source: FE Analytics
Though conventional wisdom says you should take profits when stocks are on the up and buy when they’ve gone out of favour, this is extremely difficult for investors to weather. Yet this is exactly the method Ryan uses.
Ryan (pictured), manager of the Lazard Global Equity Income fund, says he has increased his exposure to BRIC (Brazil, Russia, India and China) economies during the most recent selloff. “[This is] in sharp contrast to a few years ago when the fund had almost zero exposure, as such countries were investor darlings and valuations were unappealing,” he said.
The value-based manager says now is the time to cherry-pick some of these growing companies at cheap prices, and then it’s just a matter of time before the market turns around.
“It is somewhat ironic that the relative economic strength of the US in recent quarters has led to a dramatic outperformance of the US market, versus emerging markets,” he said.
“Typically, one would expect emerging markets to behave like a cyclical stock, outperforming during periods where the global growth outlook is improving. While many emerging markets economies face the challenge of shifting their growth from export-driven to domestic consumption-driven, investors seem to have forgotten that exports remain a key driver of growth in these economies and a rebound from current lacklustre export demand has positive implications.”
“While growth in high profile emerging markets countries like China and Brazil has slowed down materially, emerging markets as a whole continue to grow at roughly twice the rate of the developed world and consumer demand has been surprisingly resilient amid slowing economic growth due to a continued rise in discretionary income.”
The manager warns investors have become too complacent about the real level of debt in the western world.
As studies have shown that GDP growth stalls when government debt-to-GDP reaches 90 per cent, he points out the developed world as a whole is already at this level – and rising.
However, he says the emerging world has an aggregate level of debt-to-GDP at just 30 per cent, a level which Ryan says is actually falling.
“Emerging markets countries also possess significant foreign currency reserves which could be used to stimulate growth,” he said.
Beyond the sovereign level, Ryan says companies in emerging markets are more profitable than their western counterparts, which he says has been the case since the height of the financial crisis in 2008.
“Even with this higher level of profitability emerging markets stocks trade at a significant valuation discount to developed markets stocks and this discount has only widened in the recent underperformance,” he said.
“Emerging markets are also generating a higher yield than developed markets for the first time since 2008, and this dividend has much greater potential to grow. Emerging markets stocks look attractively valued both in absolute terms and relative to developed markets.”
Ryan's positive stance has seen him raise his emerging market exposure to 27 per cent in his fund, making it a significant overweight relative to both its benchmark and peer group.
How to access emerging markets
Accessing superior emerging market returns has been made more difficult by the soft-closure of the outperforming Aberdeen Emerging Markets fund and the First State Global Emerging Markets Leaders portfolio.
However, with the downturn for emerging markets, many trusts have seen their discounts widen, meaning investors can take advantage of buying into them for less than the value of their underlying assets.
The JP Morgan Emerging Markets IT is trading on the widest discount at 12.5 per cent. Its average discount over the last three years has been 9.16 per cent, according to the AIC.
The discount of the Genesis Emerging Markets IT has widened significantly over recent weeks. The trust has an average discount of 4.06 per cent over the last year, but is currently trading on a discount of 7.9 per cent.
Templeton Emerging Market IT, which is now trading on a discount of 9.1 per cent is only slightly wider than its one year average of 8.66 per cent.
Each of the trusts have taken a hit in the recent market volatility, but have bounced back strongly over the last month.
Over five years, Temple Emerging Markets has returned the most, gaining 54 per cent. The Genesis Emerging Markets IT has gained 29.46 per cent over the period while the JP Morgan Emerging Markets IT has made 38.88 per cent.
Performance of trusts vs index over 5 yrs
Source: FE Analytics
The MSCI Emerging Markets index has made 35.3 per cent over the period.