2018 was a challenging year for emerging markets. As expectations for growth fell and noise around a trade war intensified, investors fled from the asset class. It underperformed developed market equities over the year.
Short-term fears are obscuring long-term trends
To us, this is just another example of investors approaching emerging markets tactically - rather than strategically. In other words, when volatility in the market rises, investors tend to focus on short-term risks rather than on long-term opportunities.
In the short term, there has been no shortage of things to worry about in emerging markets over the last few months. A trade war, slowing global growth and quantitative tightening (or not) have been added to the traditional political volatility that comes with the territory.
In the long-term, however, well-known positive trends will continue to support emerging markets’ growth: favourable demographics; rising urbanisation leading to higher productivity; the growing importance of domestic brands driven by the expanding middle class.
A stockpicker’s market
As a result of current and short-term uncertainties, ‘valuation dispersion’ (the range of valuations between stocks in the market) is now close to its highest level since the global financial crisis of 2008/9.
In what is historically a cheap market, the range of valuations is wide. Sectors such as communication services, IT and consumer staples are still crowded and expensive, while others, like financials, telecoms and utilities, trade at large discounts to the market. This dispersion offers great opportunities to disciplined, active investors.
Take the automotive sector, for example. With annual sales of around 25 million cars, China overtook the US as the largest market a few years ago. Recently, demand has started to slow along with the Chinese economy, leading to lower valuations for Chinese auto stocks and a wide dispersion within the sector: among the 30 companies involved in car manufacturing in China, price-to-earnings (P/E) multiples range from 4x to 40x.
Contrast this with the Indian automotive sector, which serves a much smaller market of around five million cars annually. The expectations for growth are roughly the same as in China; yet investors apply a much higher price to Indian auto stocks as they shy away from the slowdown in China. 
This means that you can buy a stock with broadly similar prospects for growth at very different valuation multiples: a P/E of 4x in China or 20x in India. While some investors prefer to pay up for short-term certainty, we would rather invest in a stock at a low price where we see earnings improving.
Opportunity for value investors
Not only are global investors underweight emerging market equities, they are even more underweight the ‘value’ stocks (those that trade on below-market valuations) within emerging markets. Those same value stocks outperformed growth stocks last year.
Source: EPFR, HSBC, Refinitiv as at 31 December 2018.
We think the prospects for value are improving and that’s why, in the Artemis Global Emerging Markets Fund, we retain our significant tilt towards cheaper companies.
As a result, we have more exposure to China (including the domestic A-shares) and to Turkey, whereas we have less exposure to the more popular – and expensive – India. In terms of sectors, we prefer utilities (electricity, renewable energy) and other beneficiaries of spending on infrastructure over technology stocks or other expensive defensive sectors.
The market’s sharp rebound (at least until recently) since the beginning of the year is further proof that timing investment in emerging market equities is difficult. Investors are still under-exposed to a region which offers long-term positive trends and retains a strong bias towards growth stocks.
Peter Saacke and Raheel Altaf manage the Artemis Global Emerging Markets fund. All views are their own and should not be taken as investment advice.