InvestmentsJul 14 2014

Emerging markets ‘still set for growth’

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Current volatility in emerging market equities should not blind investors to the underlying trends of fast-rising poorer countries, according to Sarasin & Partners.

Subitha Subramaniam, Sarasin’s chief economist, said tapping this rising demand should be a key building block for any long-term investment strategy.

“After last year’s sell-off, we expect to find rewarding opportunities to ‘future-proof’ our portfolios amid the rubble of emerging markets,” she added.

“Convergence will continue to pull these countries towards Western living standards, just as economic gravity continues to shift away from the West. Now, while fickle global capital remains disoriented by crises past, this could be the best time to hunt for long-term investment ideas.”

According to Ms Subramaniam, the emerging world’s healthy demographics, high returns on physical and human capital investment, and ability to leapfrog technology generations, have powered economic convergence, lifting and steadying growth.

After a strong upswing post-crisis, Ms Subramaniam says many governments were lulled into a false sense of security and imbalances appeared in the form of rising inflation, current account deficits and external debt.

She said investors had been happy to back emerging markets while the developed world was mired in the financial crisis, but now things were recovering, they wanted to be in developed markets again.

“Over the past year, as the developed market recovery has continued, there has been a dawning realisation that it is simply a matter of time before the global risk-free rate starts to adjust higher, and investors poured out of emerging markets almost as quickly as they once poured in,” she said.

“Practically overnight, the exemplars of virtue have been turned into pariahs, and a cyclical downswing is well and truly under way.”

With capital gushing out, emerging market policymakers are working to reduce imbalances, reform budgets and privatise assets, and Ms Subramaniam said she was confident the reform fever would not fade as global pressures ease.

“A new calculus has entered the equation in the form of aspirational voters,” she added.

“Rising living standards have created a new class of voters holding governments to account, and if anything, the reform agenda will only gain momentum.”

With reform inevitably tied to the political cycle, however, emerging countries are moving at very different speeds.

In China and Mexico, where some political transition took place in 2012, Ms Subramaniam said new leaders have had time to draw up detailed plans.

“In China, for example, in the next five years the government is seeking to rein in its ever-growing state-owned enterprises, liberalise interest rates, widen the currency band, reform local government budgets and ease the one-child policy and migration restrictions on rural workers,” she added.

Wealth manager view: EM equities may have bottomed out, says L&C’s Morilla-Giner

London & Capital’s chief investment officer Pau Morilla-Giner, said wealth managers have tended to avoid emerging markets equities over the past two years due to their uncertain and volatile nature since the financial crisis in 2008.

However, he claimed he now saw signs of improvements, adding, “we may have finally reached the bottom compared to historical valuations”.

Mr Morilla-Giner said since the end of Q1, some investors had been attracted back to emerging markets, partly because of the “attractive risk-reward ratio on the back of lower valuations” and the fact they are cheap compared to developed market equities.

“We find Chinese equities pricing a price-earnings ratio close to 10-11x, whereas the S&P 500 valuation reading is roughly 18-19x,” he said.

“For investors, especially global asset allocators, these lower valuations provide a cushion for disappointment, especially at a time when many other asset class valuations are stretched.”

Mr Morilla-Giner said the headwinds facing emerging markets had “slightly receded”, and economic data, such as the HSBC Chinese Manufacturing Purchasing Managers’ index, “moved higher for a second straight month and is currently above 50, indicating expansion, for the first time this year”.

“While the valuation backdrop may be more favourable and emerging market economies are starting to show signs of stabilisation, it is not quite the time to rush hastily into emerging market equities,” he added. “However, we are advising a move from underweight to neutral on this equity sub-asset class.”