Fund Managers Disagree on EM Outlook
Prudential Portfolio Management Group said it is too early for investors to re-enter emerging markets while other asset managers argue that the recent spike in volatility is an excellent entry point into emerging markets.
David Shairp, head of research at Prudential Portfolio Management Group, said at a briefing yesterday that emerging markets equites are attractive rather than compelling.
“Equity valuations are currently at a (modest) 5% discount to global equities. Within that Asia and EMEA look attractive, while Latin America looks expensive,” he added.
Shairp argued that four things need to happen for a re-entry into emerging markets – asset valuations need to become compelling, currencies need to offer compelling value from a hard currency perspective, there needs to be evidence of macro/earnings capitulation and evidence of cleansing of balance sheets.
“The ‘re-entry’ checklist is improving, but the backdrop remains challenging and valuations are not yet sufficiently compelling to compensate for the risks that are still there,” added Shairp.
Leila Butt, senior economist at Prudential Portfolio Management Group, said at the briefing that emerging market growth will be subdued due to continued global monetary tightening, weak terms of trade, ongoing slowdown in China and low commodity prices.
“Leverage has substantially increased in some economies, with dampening effects on economic growth,” she added. “Some emerging markets have substantial imbalances leaving them vulnerable to shocks. According to PPMG’s proprietary research, Brazil, India and Turkey look most exposed.”
However Butt also said that emerging markets have some cushions, such as better balance sheets, a switch to floating exchange rates and more local currency-denominated debt issuance.
Maarten Jan Bakkum, senior emerging markets strategist at NN Investment Partners said at a briefing on the Dutch fund manager’s mid-year outlook that a prolonged risk aversion in global markets resulting from Brexit would also negatively affect emerging markets. On June 23 the UK voted to leave the European Union, which has been dubbed Brexit.
Bakkum said: “Large parts of the emerging world are still suffering from weak growth, the excessive leverage built up in the past years that limits the room for a domestic demand recovery, a high reliance on foreign capital and increased political risk.”
However he added that developed markets’ central banks are likely to remain supportive for longer, partly due to Brexit which should help capital flows to emerging markets. NN Investment Partners has a small underweight in emerging markets due to continuing doubts about Chinese growth. In contrast the asset manager is overweight in sovereign hard currency emerging market debt as valuation support and yield attracts investor flows.
Bakkum added that Brexit has also increased the likelihood of an extended period of US dollar strength, which is never good for emerging markets. “Global trade was already weak but Europe is the main trading partner for central Europe and Asia. More headwinds for global trade could also emerge after the US elections,” he said.
Jan Dehn, head of research at emerging markets specialist Ashmore Investment Management, said in a report this week that the Brexit vote caused a spike in the VIX index, a measure of volatility, of more than 10 points in June.
“VIX spikes of this magnitude have in the past always been excellent entry points into EM with an average alpha of 3% in the following 12 months relative to a strategy of passively timed allocations,” added Dehn. “Moreover, flows into EM fixed income hit a new record last week.”
The Institute of International Finance, the trade group of financial institutions, said in report that growth for emerging markets in the second quarter was on pace for the best quarter since 2014 following the largest monthly advance in four years in May.
“Our EM Growth Tracker points to another uptick in June, implying the highest quarterly growth since 2014,” added the IIF. “The further improvement in the June Tracker figure comes in the context of more stable oil and broader EM asset prices, as well as a rebound in portfolio flows.”
The IIF continued that Brexit is unlikely to have a significant impact on EM growth outside of EM Europe, but spillover effects could add to existing headwinds especially if financial stress and risk aversion have a more negative impact on EM financial condition.
Dehn added that last week saw EM bond funds post the largest weekly inflow on record according to new data from JP Morgan with the bulk going to actively managed funds.
“This increase in flows comes on the back of strong performance year to date and proven resilience in the face of expectations of several rate hikes from the Fed this year and the volatility caused by the UK’s Brexit vote,” he said. “It is possible that EM allocations may soon become the subject of a broader momentum trade, having been out of favour for some time.”
Dehn continued that while central banks are still pursuing very loose economic policies in developed economies, asset prices in those economies offer an increasingly unattractive risk-return propositions.
“As this becomes clearer we expect the QE momentum bandwagon to give way to more value-oriented strategies that give greater confidence to investors that they are adequately compensated for the risk they are taking. And that means EM,” he said.
More on emerging markets:
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