Emerging markets remain uncertain

This article is part of
Understanding ‘Value Investing’ - August 2013

Remi Ajewole, a fund manager in the multi-asset team at Schroder Investment Management, says: “When we look at the p/e in emerging markets from the MSCI Emerging Markets universe, we see it has fallen to roughly the 10 level, which is normally an environment where the subsequent returns are quite attractive. If you are a value investor, then based on this emerging market equities look like a more interesting proposition today.”

Matthew Vaight, manager of the M&G Global Emerging Markets fund, agrees: “Following the recent market falls, the valuations of emerging market equities are now compelling. On a price-to-book ratio, emerging market equities are currently trading around their lowest level for many years, and are cheaper than developed market shares by some 25 per cent.”

Mr Vaight claims that the current low valuations in emerging markets are influenced by “sentiment and macroeconomic concerns”, in particular weaker economic growth and softening commodity prices.

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He adds: “Although emerging market companies on the whole generate a higher return on equity (ROE), and are therefore more profitable than their counterparts in developed markets, they are now trading at a significant discount to western companies. While the falls in emerging market share prices may be justified by the decline in corporate performance, the magnitude of the sell-off is arguably too great.”

The M&G manager cites a number of value opportunities in “out of favour cyclical sectors” in emerging markets, such as the mining or financials sectors.

“The Brics [Brazil, Russia, India and China] were the fashionable markets in the past decade but have fallen out of favour recently. This is where we are now seeing the most attractive opportunities and focusing our efforts”, Mr Vaight explains. “The challenge in places like China and Russia – and to a lesser extent Brazil and India – is finding companies that are well managed and create value for all their shareholders. The valuations of iron ore miner Vale and oil & gas producer Petrobras from Brazil appear to be at odds with their long-term potential.

“Investors are also undervaluing the prospects of Barloworld, a South African company that distributes Caterpillar equipment, and Russian oil firm Lukoil.”

But Ms Ajewole states that the issue for any form of value investing is identifying the trigger or catalyst. This, she claims, is difficult to uncover in what appear to be value opportunities in emerging markets today. “If we look at the commodity universe in developed markets and that in emerging markets, the reasons that the latter universe looks cheap today are twofold. Firstly, growth is low and secondly, emerging economies are seeing a slowdown, especially China.

“A lot of these economies, taking the example of China, are having to restructure and change their growth model from being export orientated to more consumption led. This means a slowdown in the demand for commodities. While I can argue for a value proposition, I can’t see the catalyst yet in order for an investor to unlock the value that exists.”

It could be argued that value investors are caught in a catch-22 situation, with developed markets currently offering more growth-type opportunities and it being too early to really take advantage of the potential value opportunities in emerging markets. Fidelity’s Global Special Situations fund manager Jeremy Podger, says: “The issue with the cheaper stocks on a price-to-book and price to sales basis in emerging markets is that a lot of those are in the heavy industries – steel, cement, basic materials – which aren’t necessarily at a low point just yet.