We’ve all read the headlines about how the Faangs are propping up the US market – but it’s not only the world’s largest economy that is relying on a narrow base of stocks to deliver outperformance to investors.
Emerging markets are very much in the same boat. For example, did you know that out of nearly 1,400 stocks, just two, Alibaba and Taiwan Semiconductor Manufacturing Company, accounted for more than 40% of the MSCI Emerging Markets index’s returns in the third quarter of 2020?*
Despite emerging markets recovering some 96%* from their pre-Covid peak, investors remain unconvinced of their attraction, with around £500m of net outflows in the IA Global Emerging Markets sector between April and August 2020**.
While still fruitful, the past decade has not garnered the same spectacular returns seen previously. That’s in spite of the fact that changes were taking place at speed – a move away from energy and materials and towards the consumer and information technology, for example.
Accelerated investment trends
Like other parts of the world, Covid truly has accelerated these trends. A recent article from Matthews Asia points to e-commerce as a classic example of the pandemic re-shaping consumer buying patterns. It cites the convergence of e-commerce and physical retail into a fast-growing “super-sector” referred to as the omnichannel.***
The rise of technology has really magnified the need to view emerging markets on a country-by-country basis. Concerns surrounding the management of Covid remain present across almost all emerging markets, with the possible exception of north Asia – which has been lauded for a strong response to the pandemic. The likes of India, Brazil and South Africa face a more challenging outlook with re-opening of economies coming at different stages – meaning recoveries also come at different speeds.
So it’s perhaps no surprise that north Asia is where the tech growth is principally coming from.
China offers the strongest example of this where consumer discretionary and communications services sectors, which contain the largest internet companies, led returns. But as a research note from Lazard points out, when you look more closely at these sectors, three stocks — Alibaba, Meituan, and Tencent — have been responsible for nearly 90% of China’s outperformance in 2020*.
Growth outperforms value once again
This also brings to light the disparity between growth and value once again. In China, as with many other economies, investors have rewarded growth stocks substantially more than value stocks for their earnings. Growth stocks have delivered a 76% return over the past year in China, led by the consumer, technology and healthcare sectors, compared to just under 2% for value stocks****.
The valuation premium for growth stocks recently hit a new all-time high as a result, in spite of a significant improvement in industrial profits. The story runs true for emerging markets as a whole, where the disparity of growth stocks over value now stands at 62% over the past five years*.
Make no mistake, valuations in emerging markets have looked better. Whether it’s forward or trailing PEs, price to book or dividend yields – emerging markets are expensive when compared to 15-year averages^. Although you could argue they look expensive in most parts of the world^.
A recent update from JP Morgan Asset Management says that while valuations remain unexciting, earnings expectations are starting to become less negative for the region. It added: “Earnings revisions are positive for technology companies and other Covid beneficiaries, like healthcare and e-commerce. Additionally, more sectors are seeing positive revisions, including energy. Emerging market equities’ two-year forward returns from previous crises lows have ranged from 5% to 120%, so there is still the potential for the asset class to run further from the late-March bottom.”
The final quarter of 2020
The final quarter sees a US election, which will clearly be of interest to the region, as will the ongoing geopolitical scrambling between the US and China. Reforms in the likes of India and Brazil – as well as concerns in Turkey – reflect the growing need to view each country’s outlook individually. Our view on emerging markets has gone from an overweight to more of a neutral in the past 12 months. Yes, the valuations are unattractive but there are always going to be significant growth opportunities for the right active manager.
Funds to consider to access emerging markets
Good options to consider in the region include GQG Partners Emerging Markets Equity, managed by Rajiv Jain, which is a concentrated portfolio of high quality companies with durable earnings. The emphasis is on future quality, rather than companies which have simply done well historically.
Another is the FSSA Global Emerging Markets Focus fund, which invests in 40-45 large and medium-sized companies.
Those looking for Asian equity specialist may like Matthews Pacific Tiger, which is run by a strong team that focuses on corporate governance and has expert local knowledge it uses in its search for high quality, capital light businesses.
*Source: Lazard AM – Outlook for Emerging Markets – October 2020
**Source: Investment Association
***Source: Matthews Asia – E-commerce Sizzles – October 2020
****Source: Fidelity Multi-Asset Market Update – October 2020
^Source: Schroders – Which stock markets look cheap as we enter the final quarter of 2020?
