Those managers who have typically been more defensive and steered their investment process towards absolute return have sheltered investors from most of the decline. Here I am thinking of First State and its large investment team headed by Angus Tulloch in Edinburgh. The First State Global Emerging Markets and Global Emerging Markets Leaders Funds fell -3.0% and -3.7% respectively. Other notable performers for the year to date include two perhaps less well-known names, Hermes Global Emerging Markets Fund (-2.1%) and Somerset Emerging Markets Small Cap Fund (-2.1%).
Fragile growth
Today many of the major emerging markets – Brazil, Russia, India and China – are suffering from growing pains, mainly stemming from the global financial crisis, a creation of western economies. The long term growth story for emerging markets, born out of the growth of the middle classes and government infrastructure spending to support private investment, is well-understood. Over the last decade the acceleration of the wealth transfer from West to East has resulted in these economies contributing more and more to global economic growth. However rapid growth needs to be handled with care, particularly when coupled with the challenges inherent within structural change and reform.
Following the 2008/9 crisis, economic growth in emerging market economies remained robust, leading to strong investment flows. This accelerated growth and inflation in the regions, particularly as some authorities were reluctant to see their currencies strengthen, a development which would undermine the competitive advantage that they had so effectively exploited for many years. However, inflation has risen, and with increasing domestic demand, wages have increased sharply too – in China particularly. These economies have lost some of their competitive edge, with growing imports deteriorating trade surpluses.
Difficult choices
If western economies are facing some difficult choices, so too are emerging markets, where economic growth is slowing and inflation remains high. As a result, interest rates will have to rise to combat inflation in consumer prices which will be negative for bond and equity investing.
There is also a close relationship between commodity prices and emerging markets. Producers in Brazil and Russia rely on consumers in India and China. Slowing demand has resulted in weaker commodity prices which have added to further selling pressure. These views on the economy and commodity prices, I believe, have already been reflected in bond and equity markets.
Clearly, some investors have chosen to reduce weightings in favour of economies at a different stage of the economic cycle. Indeed, prices have now fallen to levels where valuations are considerably cheaper relative to those in western markets. These valuations, however, reflect the less favourable fundamentals of today and may present an entry point for long term investors wanting to build up their holdings.
