Emerging Markets  

Are emerging market equities more attractive than EM bonds?

This article is part of
Guide to investing in emerging markets

Are emerging market equities more attractive than EM bonds?

The election of Donald Trump as US president in November last year prompted an emerging market bond sell-off.

The asset class does appear to have recovered somewhat as the White House administration has floundered, stumbling from one crisis to another.

Meanwhile, emerging market equities are on a similar road to recovery, growing again after years of decline and finding favour once more among UK investors.

Should investors be favouring one asset class over the other in their portfolio?

It seems investors still need convincing of the case for allocating to emerging market equities, even though they represent good value when compared to developed market equities, where valuations are at near all-time highs. 

Global emerging markets account for approximately 12 per cent of the MSCI World index and investors are around 4 per cent underweight, according to Dan Tubbs, head of the global emerging markets (GEM) equity research and portfolio management team at Mirabaud Asset Management.

He points out investors have not been this underweight in emerging market equities in about five years, although more recently flows into GEM equities have begun to improve.

He also dispels the myth investing in emerging market equities is simply a play on commodities.

“In fact, energy and material stocks account for only 7 per cent of the index each,” he notes. “The GEM universe is actually much more of a play on global technology as the largest sector in the MSCI Global Emerging Markets index is now technology, with a 25 per cent weighting.”

In spite of a pick-up in interest in emerging market equities this year, investors are still underexposed to the asset class.

Figure 1: MSCI Emerging Markets index daily performance over five years to 1 September 2017

Source: MSCI

Ross Teverson, head of strategy, emerging markets at Jupiter Asset Management, explains: “We see reasonable valuations (or attractive valuations if one compares emerging market equities with developed market equities) in combination with scope for positive earnings surprises as key tailwinds for emerging markets.  

“Also, despite the decent fund flows seen into the asset class so far during 2017, the legacy of a challenging four-year period for emerging markets prior to 2016 is that many investors remain under-allocated.”

Attracting flows

Mr Teverson suggests should emerging market companies continue to deliver solid earnings growth, it is likely more money will flow back into EM equities, and with many emerging market companies boasting strong balance sheets there is plenty of opportunity for improved shareholder returns.

He takes Samsung Electronics, the second largest constituent of the MSCI Emerging Markets index, as an example of a company with an attractive valuation, scope for further positive earnings surprise and a strong balance sheet.