India, China hold pockets of investment opportunity
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Romina Graiver, who heads up emerging market equities for fund manager William Blair, believes these could be a good fit for your portfolio--and here's why.
The gap between emerging market economies and those of developed markets are narrowing, creating considerable opportunities for investors, according to Romina Graiver, product specialist, global and emerging markets equities, William Blair.
In the year to August 2016, upwards of US$9 billion have flowed into emerging market equities. This is a complete turnaround from previous years, when emerging markets saw outflows of US$49 billion in 2015 and $25 billion in 2014.
"We see a complete reversal versus the last couple of years, where emerging markets were lagging, and this is largely due to the strengthening dollar, which has allowed prices to rebound, and improved emerging market terms of trade," says Graiver.
"When you put together the dollar trend valuations, and more positive earnings, it's not surprising that we've seen very positive flows."
She believes these flows are underpinned by fundamentals, including corporate performance, dollar trends, commodities and overall growth in gross domestic product levels. Collectively, these point toward a positive outlook for equity investment in these countries.
"The growth differential between emerging market and developed markets is narrowing, so emerging markets continue to grow faster," Graiver says.
Over the past three years, the differential has been contracting, "and that has proven to be a leading indicator for the relative performance of emerging market equities, relative to those in developed markets".
A window of opportunity
While there is no shortage of global fund managers who offer access to emerging markets, there are still advantages to be had for investors.
According to Graiver, the rate at which fund managers are adopting underweight positions in Europe has been accelerating, and also in Japan.
"So when you look at surveys about where fund managers are exposed, we see that there are negative flows and they're underweighting Europe compared to their historical positions. They're still underweight emerging markets, but the gap is being closed," she says.
How appropriate are emerging markets for conservative investors?
"Emerging markets are an attractive asset class, as part of a diversified exposure to equities," Graiver says.
"I wouldn't recommend using it as a sole exposure for a pension, but it has this element of un-correlation ... it's about diversifying for a broad portfolio, the sources of growth.
"[Emerging markets] are faster growing, with more risks involved, and that's why you have to consider it as part of a broader selection of assets."
Graiver also emphasises that emerging markets are perhaps not as exotic or unpredictable as they once were.
"It's an asset class that has become more mature compared to where it was 10 years ago," Graiver says.
"In terms of how you approach emerging markets, when we first started in this space back in 1996, it was really about corporate discovery and new companies that nobody knew about.
"The growth story was about discovery. We've now seen the asset class evolve, and now there's a very interesting story about execution and finding leaders.
"These are companies that may be emerging market companies, but they're leaders in global standards ... great companies that are producing higher returns and better products, in some cases, than in developed markets."
She refers to China as an example of this, having been previously known primarily for cheaper, inferior versions of products available in western markets.
"And now, we're seeing much higher quality coming up the value chain. There is an evolution of how portfolio managers have been positioning and managing portfolios in emerging markets."
Top picks in emerging markets
"India is a country where we've been overweight and continue to be so ... [though] it's a country that's more of a consensus view," Graiver says.
She describes the political landscape "where expectations initially ran ahead of reality" but it's starting to materialise now. A lot of changes were not visible, have taken longer to come to fruition. But they're clearly on a good path".
"It's now the fastest-growing country in the world ... younger demographics continue to grow when in many cases, these have peaked and are in a downward trajectory [in other markets].
"There are also a number of other factors, including lower commodity prices, which continue to be a tailwind for India."
China is also an area of focus for William Blair, but it looks for specific pockets of opportunity rather than an overall country exposure.
"Chinese tourism is a theme we like to play, [which cuts] across different areas. Cosmetics; airports in many Asian countries are benefiting from this too," she says.
"Tourism spending among Chinese citizens has overtaken the US ... that is a tailwind for many sectors and regions in Asia and more broadly."
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Glenn Freeman is Morningstar's senior editor.
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