S&P Fund Services discusses how emerging markets have fared in the recent volatile climate and what lies ahead
With the governments of countries introducing austerity measures around the world, our latest sector review examines how emerging markets have fared and continue to fare in the current economic climate.
Over the first six months of our review, which spans 1 May 2009 to 30 April 2010, markets delivered strong returns. This was in contrast to what was seen during the previous 12-month period, when heightened volatility, driven by the collapse in commodity prices and the credit crunch, caused turmoil across the financial markets of both developed and emerging countries.
However, as central governments unveiled plans to provide some much needed financial support to the capital markets, sentiment shifted and stock markets rallied sharply from mid-March 2009. Against this backdrop, companies that had been viewed as potential or even probable bankruptcy cases, in particular those further down the market-cap scale, rallied the sharpest.
The MSCI Emerging Markets Small-Cap index, outperformed its large-cap counterpart, by over 25%, returning 83% versus 57%, respectively, during the review period. On a discrete monthly basis, the strongest relative outperformance came in April and May 2009, while September and February were the only months where large caps outperformed.
In a reverse of what was seen during the previous period, many of the smaller markets posted strong returns. In Asia, for example, Indonesia and Thailand were stellar performers having been among those hardest hit during the downturn in 2008.
Given the volatile behaviour of global markets during 2008 and 2009, very few funds delivered strong relative returns across both calendar years. Indeed, during the sharpest period of the rally in 2009 (March to May), success hinged on the managers’ timeliness in shifting portfolios out of defensive areas of the market and into those more cyclically exposed. Within the global emerging markets peer group, it was interesting to observe the AA-rated Aberdeen funds, with their focus on good-quality franchises, managed to outperform in both years, especially given the strong rally in perceived lower quality stocks – an area the team typically avoids. Other successful funds across both periods were the Genesis Emerging Markets and Skagen Kon-Tiki, both of which retained AAA ratings.
Turning our gaze to emerging European funds, the changing market conditions proved problematic overall as only a small number of funds within our review beat the peer median across both years. Nevertheless, this has to be placed within the context of the broad range of mandates that form the peer group. For example, a number of funds are managed against the Nomura Central & Eastern Europe benchmark, which has around 25% less allocated to Russia than the MSCI EM Europe index (32% compared to 58%), zero-weights Turkey (17% for the MSCI index) and has 22% higher exposure to Poland (36% versus 14%). Therefore, peer relative analysis within this sector is slightly less meaningful.
Successes within the Latin American peer group were also limited. The AAA-rated Gartmore fund, managed by Chris Palmer, lagged peers in 2009, the first time this has happened in four years. The Templeton Latin American fund also proved resilient during 2008, but it too lagged in 2009. Investors were nonetheless well rewarded as both funds delivered absolute returns in excess of 100%.
Perhaps the most noticeable trend within our review was the growing importance of the domestic consumer. This has been consistent across EMEA, Latin America and Global.
The drivers of increased wealth across emerging markets are reasonably easy to explain especially within those economies that are large suppliers of natural resources. This has particularly been the case with Russia and Brazil, where the recovery in the oil and other commodity prices has a direct benefit on local economies. Leaders of emerging markets nations are also far more cognisant of the fact export demand can be vulnerable, given testing market conditions in developed countries.
Growth projections remain high for emerging markets compared to the developed world. In China, where exports in manufactured goods to the Western nations has fallen over recent years, GDP is still expected to grow by around 8%-10% for 2010 and 2011. Expectations for India are approximately 8%, closely followed by Indonesia and Brazil at 4%-5%. The increased level of urbanisation and rapidly growing population providing the supportive backdrop. In comparison, US numbers are about 2.5%, with the eurozone and UK below 2%.
Overall, the view was positive for emerging markets, although the consensus is it is unlikely we will see a rally with such magnitude and duration as the surge experienced in early Q2 2009. Furthermore, and as we have discussed above, the standard view is the growth story going forward will be the expansion of domestic consumption.
The team at Skagen (who manage the AAA-rated Kon-Tiki fund) subscribe to the view Asia will lead global economic growth, fuelled by China, India and Indonesia. It also believes global imbalances are continuing to be reduced by increasing consumption in the emerging markets and raised savings rates in the industrialised countries. Despite the collapse across global markets in 2008 proving the decoupling theory wrong, the team still maintains a clear view that the decoupling of the world becomes more and more clear.
At Comgest, China’s strong growth is becoming a source of increased concern and raises a number of questions. It sees opinion polarising around two extreme views. The optimistic view sees China as the new superpower with a new middle class pulling the world economy along, sheltered from all crises, and whose considerable ($2.4trn) foreign exchange reserves render it invincible.
Countering this are the voices of doom, which see headlong advances undermined by a boom in poorly controlled lending that has financed massive overcapacity in industrial production, excessive public infrastructure programmes and a real estate bubble. This bubble, when it bursts, will destabilise the banking system.
The view at Comgest is that as China’s economy is not yet a market economy, its banking system remains state controlled and sooner or later the system will have to pay the consequences of poor credit risk assessment, but it is impossible to say when this is likely to be.
Chris Palmer at Gartmore sees continued growth prospects within Latin America, with his portfolio currently positioned with overweight positions in consumer discretionary and industrials. This is supported by his view local banks are seemingly robust by international standards, while low interest rates and government initiatives to stimulate growth are boosting levels of domestic economic activity. Palmer believes although Brazil will enjoy the highest growth rate, Mexico will show the greatest improvement in growth.
Meanwhile, Barings’ James Syme holds Russia as his largest overweight within his global emerging markets product. He sees Russia’s economy recovering well after the difficulties of late 2008 and early 2009. He is most positive on the outlook for the domestic economy and the consumer in Russia. The fund is also overweight Turkey following dramatic falls in inflation and interest rates over the last three to five years. He sees the legacy of the years of high inflation and high and volatile interest rates as beneficial, because the level of borrowing, particularly on the consumer front, is extremely low.
Elena Shaftan at Jupiter believes global economic conditions remain difficult and therefore markets are likely to remain volatile. If this is the case, then Russia, Turkey and Poland should benefit due to increasingly domestically driven economies with low debt and the ability for consumers to spend more. If risk aversion increases, however, then share prices will fall irrespective of the underlying fundamentals.
John Monaghan is an analyst at Standard & Poor’s Fund Services
