Multi-asset  

Emerging or developed markets – the year’s biggest conundrum

This article is part of
Multi-Asset Supplement - March 2014

It has undoubtedly been a painful start to the year for emerging markets, but many argue this has left stocks cheaper, while emerging market economies still demonstrate higher growth and lower debt levels than developed markets.

In contrast, others suggest that emerging markets will continue to suffer from the fall-out of the withdrawal of quantitative easing, and their recent rout is far from over.

There are those tentatively moving back into emerging markets. Rob Burdett, joint head of multi-manager at F&C Investments says they have marginally reduced a long-held underweight position in emerging markets. The weighting in the group’s Global Boutiques fund is currently roughly 2.5 per cent.

James Calder, research director at City Asset Management, is also retaining a weighting in emerging markets. He says the markets are difficult to time and can run up very quickly, so he prefers to remain invested.

He adds: “It is difficult to believe that emerging markets can decouple completely from western economies and valuations are becoming more attractive.” Nevertheless, he also retains a relatively high weighting in the US market, which he believes has further to rise.

Toby Nangle, head of multi-asset at Threadneedle, admits that the group is wrestling with the problem, having been over-exposed to emerging markets in 2013. While he does not buy the argument that faster economic growth means investors should buy emerging market assets, he says that selectively there are opportunities.

But cheap valuations are not luring everyone back.

Marcus Brookes, head of Cazenove’s multi-manager team, says: “We still find emerging markets a little dangerous and have zero weighting in our Diversity fund. Two and a half years ago, these countries were trading at rich multiples, so we thought they would devalue on disappointing earnings. The withdrawal of quantitative easing is a new dynamic. Fewer dollars printed should mean a stronger dollar and historically that has always created problems for emerging markets.”

Mr Brookes says that many emerging markets have effectively imported US monetary policy, through their dollar borrowing: “US monetary policy is great for a stodgy, mature economy struggling to re-fire, but less so for an emerging market. China could be the Japan of the late 1980s.”

A developed market preference is seen among UK managers as well. For years, UK managers suggested that a key advantage of the UK market was its overseas earnings potential, but this has notably shifted. Managers such as Tineke Frikkee, manager of the Smith & Williamson UK Equity Income trust, says she is more focused on domestic earnings, on valuation and economic momentum grounds. Her only real exposure to emerging markets is via small positions in the mining sector.

Richard Buxton, manager of the Old Mutual UK Alpha fund, says: “There is likely to be momentum in the UK economy over the next two to three years. It won’t be completely one way, but it will be good for domestic-facing companies.

“The longer-term case for faster growth in emerging economies is certainly still intact: they have demogaphics and globalisation on their side, but there are areas such as fuel subsidies, which have the potential to derail some emerging market economies.”