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Emerging markets down, but not out

Nicki Bourlioufas  |  03 Jun 2019Text size  Decrease  Increase  |  
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Emerging markets are still worth a wager, fund managers argue, despite the heavy toll of escalating trade tensions, sluggish growth in developed nations and economic stress in Argentina and Turkey.

Fund managers say that investing in emerging markets involves a lot more risk than investing in developed markets. Yet with prices down over the year, now might be the time to consider an increased allocation. Such investments could offer diversification and growth opportunities.

The MSCI Emerging Markets Index is down 10.3 per cent over the year to 31 May, which included an 11.6 per cent slide in Argentine stocks last month.

Chinese share markets have fared better than other emerging markets. China’s A-shares benchmark CSI 300 Index was down about 4 per cent over the year to 31 May.

That compares to stronger gains in developed markets. The S&P ASX 200 is up about 6 per cent and the S&P 500 is up about 3 per cent over the year. 

According to Forager analyst Alvise Peggion, investing in emerging markets shouldn’t be any different to investing in developed ones, though the risk of a permanent loss of capital is higher than in developed markets.

“You estimate the present value of an investment’s cash flows and buy at a discount to that value to compensate for the many risks. Keeping this in mind, there are a number of specific things to consider when looking for value in emerging markets,” Peggion says in a recent paper, How to Invest in Emerging Markets.

“Governments frequently intervene in many emerging markets. This covers everything from unfavourable regulation to the Chinese government’s direct intervention in the share market … Corporate governance standards are still low. If the government is not running the show, then a controlling family most likely is,” says Peggion.

“Liquidity is also low. It can take only a few relatively small trades to move stock prices meaningfully. Finally, investors are exposed to local currency depreciation. This can quickly wipe out the value of their investments.”

Peggion says investors should be looking for much bigger discounts to compensate for the higher number of investments that are likely to go wrong. “When investors face riskier investments, they should demand higher returns. Which implies paying lower prices.”

Todd Hoare, a global equities analyst with Crestone Wealth Management, says the benefits of emerging markets investments in portfolios largely come from diversification and access to stronger growing parts of the world economy.

“The individual constituents within emerging markets are often less correlated to broader global equity markets,” Hoare says.

“In many ways, Australia is a play on emerging markets, especially China, given our iron ore and coal export exposures. Our terms of trade, the Australian dollar and fortunes of the big miners are a derivation of China’s demand for our natural resources.”

Hoare’s slight overweight position to emerging markets is hinges on the longer-term belief that world GDP growth will continue to be driven by the growing middle class of Asia and the Americas.

“With that said, there can be no denying that should the world enter into a prolonged economic slowdown, it is likely that emerging market equities, as an asset class, would underperform developed markets, especially Australia and the US.”

While emerging share markets might fall still, the IMF expects improved global growth in the second half of 2019 and in 2020, with Asia especially growing faster than the rest of the world.

“Beyond 2020, global growth is expected to stabilise at around 3.5 per cent, bolstered mainly by growth in China and India and their increasing weights in world income.

"Growth in emerging markets and developing economies will stabilise at 5 per cent, though with considerable variance as emerging Asia continues to grow faster than other regions,” the IMF forecasts.

As for the current dip in emerging market prices, "for long-term investors, this will likely represent buying opportunities but as with all investments, it will depend on the severity and duration of any slowdown and prevailing valuations at the time," Hoare says.

His preferred investment vehicles for exposure to the region is actively managed funds, "where experienced managers can address the inefficiencies that often exist in less researched markets.”

“Such an approach is best able to efficiently access growth opportunities across a broad spectrum of emerging markets while addressing any potential governance issues more easily than a passive approach."

 

 

is a Morningstar contributor.

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