Regaining control

Developing economies took a pasting early this year after a number of macro-economic headwinds spooked investors and led to them selling out of these markets. Confidence is slowly starting to rise, however.

For the longest time investors seemingly forgot about the risks inherent in emerging markets. They were enticed by the double digit growth stories and returns of China, India and Brazil, but then last May the Federal Reserve pulled the quantitative easing (QE) rug from under everyone’s feet. Stocks tumbled, cracks appeared and differentiation becomes the buzzword.

“Emerging markets are not efficient,” says Jan Dehn, head of research at emerging markets specialist Ashmore Investment Management. “Every time something goes wrong, whether it is tapering in the developed markets or Greece blowing up or a crisis in the Ukraine, investors get nervous, sell these markets and buy assets in the US or Europe. It is a temporary moment of insanity and often does not take into account what is happening to the underlying fundamentals.”

This was particularly true in the first half of the year when headlines of conflict and violence in countries including Ukraine, Turkey, Thailand and Nigeria, along with doubts about the readiness of Russia to host the Winter Olympics and Brazil to hold the FIFA World Cup, made investors skittish. They pulled a hefty $50bn from emerging stock and bond funds between January and March, which was more than double the $15.2bn outflows for 2013.

A SHIFT IN CONFIDENCE

Nerves started to settle in the second quarter in the wake of India’s post-election resurgence of hope, the softer than expected landing of China’s economy and the upgrade of Qatar and United Arab Emirates from frontier to emerging market status. The momentum started in April and to date June has been the best month with bonds dominating the scene, garnering $29bn of inflows while equities accounted for $7bn of the total $36bn emerging market bounty, according to the latest report from the Institute of International Finance, a global financial industry group.

This was slightly down from May’s $38bn but up from April’s $28bn. The renewed interest pushed emerging bonds higher by 9% while equities increased 5% in the first six months. However, according to Mark Mobius, executive chairman, Templeton Emerging Markets Group, who has always advocated patience, a long-term perspective and selective stock picking: “During the last 10 years, there have been only three years when emerging markets underperformed developed markets, 2013 being one of them.”

“We have definitely seen a shift in confidence,” says Emily Whiting, client portfolio manager in the JP Morgan Asset Management Emerging Market Equity team. “The industry has seen net inflows in April after 22 consecutive months of outflows which left the majority of investors oversold and underweight. They are now increasing their exposures but activity is muted and it seems to be more of a drip feed rather than the floodgates reopening.”

Institutions have also become more discerning. “One of the things that has come out of the last 12 months is a greater awareness that emerging markets are not a homogenous group,” says Simon Hill, head of investment research at Buck Consultants. “There are still big overreaching themes at work but there is more attention to the different factors at play in individual markets.”

HOLD YOUR NERVE

Unearthing those opportunities though will be harder than in the past when every asset with an emerging market label seemed destined for an upward trajectory. “The best time to have bought was in mid- March, according to East Capital chief economist Marcus Svedberg. “There was Russia and Ukraine, the coup in Thailand and the impending elections of the so-called fragile five – Indonesia, South Africa, Brazil, Turkey and India. If you held your nerve, you would have made a lot of money, but if you were really smart you would have bought in March.

“ The truth is most of the things people worried about did not materialise and while not much has changed for the better or worse, the worst case scenarios – Russia invading Ukraine and China’s hard landing – did not materialise.”

BEING SELECTIVE

Svedberg, along with others, believes that China, India and Russia still offer relatively good value compared to their developed peers. For example, the International Monetary Fund predicts China’s growth rate will stay in the 7-7.5% range over the next two years while analysts are optimistic that the landmark economic reform blueprint drawn by Communist Party leaders last year will bear fruit.

The transformation of the country’s growth model away from an export led to a more domestic consumption and services will take time, but analysts predict that the main beneficiaries will include healthcare, renewable energy, retail, and non-bank financials. Even traditional industries like utilities and oil and gas could benefit from the deregulation of energy prices. Fund managers are much more bearish on Brazil although the stock market – unlike the fans – cheered the humiliating World Cup 7-1 defeat by Germany.