Ever since the US first indicated the withdrawal of its massive liquidity programme, many global investors have shunned emerging markets (EMs). Pessimism towards major economies such as China has grown and market volatility is high. However, valuations for EMs on a price-to-book basis are getting close to their lows during the financial crisis. So, after four years of EMs underperforming developed markets (DMs) and a big divergence in valuations, we believe now is a favourable time to be invested in emerging markets, but on a highly selective basis.
In late May 2015, the International Institute for Finance reported that fund flows to EMs were likely to be at their weakest since 2009. Without steady inflows, EM countries have less money to pay debts, finance deficits and invest in infrastructure and corporate expansion. Recent outflows have been due mainly to the anticipated rate rise from the Fed and concerns about future growth prospects. Company earnings in general have disappointed expectations, meaning that investors are less inclined to tolerate other EM risks such as higher volatility, government intervention and currency depreciation.
Primarily, however, money has flowed away from EMs over the last two years and towards the US dollar and developed market assets, as the mass “carry trade” of borrowing cheaply in the West to invest in EM equities and debt for a higher total return has unwound. All these factors can have a negative effect on growth and many investors therefore allocate more of their portfolio to less volatile DMs where returns in the short term may be higher.
However, we are currently seeing significant divergence between emerging economies, stock markets and companies, creating opportunities for EM specialists to find value. India’s economy is benefiting from depressed commodity prices and is expected to continue its growth trajectory as further reforms are implemented by pro-business Prime Minister Narendra Modi. Meanwhile, in countries such as Russia and Brazil, whose economies have been hit by falling commodity prices among a number of factors, the broad market sell-off has created a number of attractive valuations.
