But the risk aversion which has penalised emerging markets has created an attractive opportunity to invest in these economies, which on a medium to long term view exhibit superior fundamentals.
In all market conditions
Over a five-year timeframe, emerging markets will benefit from public balance sheets that are in far better condition than those in developed markets. Emerging markets will also, on average, grow 4% faster than developed markets, in both recessionary and expansionary periods. Inflation has now peaked in most developing economies, which means a much more constructive environment for bonds and equities.
One of the most important drivers for growth in emerging economies is the improvement of living standards. We particularly like emerging market companies with exposure to increased spending by domestic consumers. Export-oriented sectors are less attractive, particularly with ongoing uncertainty over global growth. But European companies which derive a substantial proportion of their earnings from overseas also stand to benefit from emerging market growth, particularly with a more competitive euro.
We also favour companies with healthy balance sheets. Balance sheet quality seems to us to be crucial in cyclical sectors. The growing cost of risk in all asset classes increases companies’ financing costs.
While the financial sector is still subject to uncertainty, those financial sector companies we hold are very well capitalised and operate in countries with a low level of private debt, like the Philippines and Colombia.
We believe that the best way for investors to access emerging markets is through a diversified global portfolio, rather than through specific regional funds. This means that the fund manager can respond to changing market and economic conditions by shifting money to those countries that offer the best opportunities.
But if you like the regions…
China is currently one of our favoured markets. It is in a strong situation, and once it has managed to bring the property market under control, it will be able to manage a soft landing of its economy. Valuations are back at 2008/2009 levels.
India has been a disappointment, but with inflation topping out, the central bank will be able to continue cutting rates, which will benefit the economy and the valuation of financial assets which currently look reasonable.
In Brazil, the government needs to deal with infrastructure bottlenecks, as well as reduce inflation. But with prices starting to come down, there is scope for monetary easing from very high real rates.
Among the smaller emerging markets, countries with dynamic economies, like Indonesia and Chile, have made a substantial contribution to the performance of our emerging markets funds over the past year.
Our positions in countries like Thailand, the Philippines and Peru (2%) have also contributed positively to performance.