Patience is the key for emerging market opportunities, says Darius McDermott, managing director, FundCalibre
It’s been a challenging 12 months for emerging markets (EMs) as a convoluted vaccination process and regulatory tightening in China both hung heavily over the economic prospects for the region.
At the end of 2021 the MSCI Emerging Markets Index was down 1.6 per cent, underperforming the developed markets MSCI World Index by 24 percentage points*. While vaccination programmes have started to pick up markedly, 2022 has continued in an uncertain vein, as investors wait to see how concerns over China and inflation play out.
From a broad basis, valuations in EMs are also not cheap relative to history. However, if we look beyond the main figures there are a number of alternative factors to consider. The first is there are considerable variations in terms of sector, stock, and investment style in EMs – so there will be pockets of opportunity. The second is EM valuations are nowhere near as expensive as US equities.
The waiting game on China and inflation
It’s important to recognise EMs are evolving – nine out of 10 larger EM economies are now classified as investment grade, with solid balance sheets, so when we do see a significant sell-off it should pose less of a systemic risk to the region.
However, there is no doubt that any significant swing in China’s economic fortunes continues to ripple across the wider region. Much has been made of China’s regulatory tightening across numerous sectors last year and the subsequent slowdown. Chinese officials have begun to try and remedy this – for example in December 2021, the People’s Bank of China reduced the reserve requirement ratio by 0.5 per cent, releasing almost $200bn of liquidity**. This indication from policymakers that they are willing to stabilise growth is extremely positive and, with Chinese equities falling more than 30 per cent since February 2021***, they could be attractive from here.
Worries over US inflation and the direction of US monetary policy also came to the fore for EMs in 2021. Inflationary threats in the region are more pressing simply because food accounts for a larger portion of production. Key EMs such as Brazil, Mexico, Russia, and South Korea moved ahead of developed markets in raising interest rates to curb price pressures.
Could fortunes change in the second half
The impression is that 2022 will be tough for EMs from a growth perspective. However, there is scope for positive surprise if investors are patient. China has been challenging – but valuations do offer value now; there is a rapid growth in both digitisation and decarbonisation in EMs; while fiscal and current accounts are in better shape than they have ever been before.
Ultimately, the fast half of this year has a ‘wait and see’ element to it. China looks to have hit the bottom and there is hope that inflation will ease, with figures from the IMF indicating it could fall to about 4 per cent by the middle of this year****. Covid is also an uncertainty that EMs, like the rest of the world, are learning to live with.
I believe there could be opportunities later on in the year if we do see the fog clear on these challenges. Over the past two years, success in EMs has been dictated by whether you’ve held China (in 2020) or India (in 2021). There is no doubt China looks the more attractive of the two today – but the entire region could be an ideal hunting ground for selective stock pickers’ in the not too distant future.
Funds to consider:
GQG Emerging Markets Equity – This 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.
Magna EM Dividend fund – It is worth noting the shift in style performance last year – with value stocks returning 4 per cent compared to an 8 per cent fall for EM growth stocks*. Magna EM Dividend fund is a 40-55 stock portfolio offering exposure to emerging market companies that pay higher than average dividends. The portfolio has a value profile because it won’t own some of the big tech names as they do not pay an income.
JPM Emerging Markets Trust – Quite simply, this trust has a 30-year track record of delivering exceptional returns. The team take a long-term approach, with the focus on companies, not countries.
Aubrey Global Emerging Markets Opportunities – is set up explicitly to take advantage of the fast-growing emerging market consumer opportunity and currently has more than 80%^ of the portfolio in Indian and Chinese stocks.
Emerging market investment characteristics
Positives
- Strong demographics/growing middle class
- Higher growth than the developed world
- Market has shifted from export-led to consumption-led (rise of digitisation has only just begun)
- Dividend payments are only just starting in the region.
Negatives
- Returns are often more volatile
- Politics are mixed/uncertain
- Fluctuating currencies and fortunes tied to the US dollar
- Outlook for China still plays considerable role
*Source: FE fundinfo, total returns in sterling, calendar year 2021
**Source: Lazard Outlook for Emerging Market – January 2022
***Source: FE fundinfo, total returns in sterling, 1 February 2021 to 1 February 2022
****Source: IMF World Economic Outlook – October 2021
^Source: fund factsheet, 31 December 2021
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.
This article was first published in the March 2022 issue of Professional Paraplanner.
[Main image: edz-norton-lVd5b63876g-unsplash]
