When the going gets tough
This five-pronged attack on the emerging market growth is particularly challenging given the region’s sensitivity to negative sentiment and low investor confidence. As evidenced by the Bank of America-Merrill Lynch global fund manager survey, investors are quick to pull out of the developing world when it gets uncomfortable.
Whiting says: “The emerging markets as an asset class is very confidence and sentiment based – more than other asset classes – and we notice in times of trouble and fragility we seem to be the market that suffers most.”
But all this negative sentiment could well be misplaced. Simon Hill, chief investment officer at Buck Global Investment Consulting, believes the fall off in emerging market equity performance simply represents a return to normality and there has been something of an overreaction from investors.
“Chinese growth is still decent and the Asian economies are still buoyant; they are performing well although less hectically than a few years ago. Some adjustment was inevitable, and the froth and euphoria about emerging markets were bound to be blown off at some point,” Hill says.
Taking China as an example, the pace of growth has undoubtedly slowed from the lofty predictions of recent years, but the Organisation for Economic Co-operation and Development (OECD) still expects the country to experience annual economic growth of 6.6% up to 2030 which is three times the 2.2% rate of expansion predicted across the OECD countries over the same period.
It is also worth remembering that the emerging markets are made up of 20 distinct countries which are not entirely correlated and while some constituents may be suffering, others are able to thrive.
Whiting says: “These markets have different drivers and catalysts and are at different stages of development. In some places commodity prices hurt while in others they help. Consumer spending and domestic demand is at a different level across markets. It is misleading to say the emerging markets as a whole are suffering at the moment.”
Keep the faith
Advocates of emerging market equities argue that far from running away from developing markets, pension funds should take advantage of the situation and cash in on some good value stocks.
“The average long-term valuation for emerging markets is two times price to book. Currently we are at 1.6 times which puts us in cheap territory. This is a time investors should be accumulating exposure to emerging markets,” Whiting says.
And it could be that UK pension funds do have faith in the long-term prospects for emerging markets. A survey by Natixis Global Asset Management reveals institutional investors have a genuine appetite for the region, with 46% adding to their emerging markets equity allocations.
The Mercer 2013 European Asset Allocation Study also found amid a general decrease in equity allocations as a whole, pension schemes have made significant progress in increasing allocations to emerging markets. Mercer says: “Emerging markets are now a staple part of many plans’ equity portfolios, reflecting the more favourable long-term growth outlook for these economies.”
Natixis says pension funds are including emerging markets in ‘new world’ investment strategies designed to deal with significant liability shortfalls. The asset manager’s survey found 83% of investors have identified the need to replace traditional diversification and portfolio construction techniques with new approaches to achieve results.
Hill says: “The long-term case for pension funds to invest in emerging worlds with a younger population is an entirely sensible way to address their own maturity. I regard this as an opportunity to invest at a less elevated price than we saw a year ago.”
Indeed, Wandsworth Council Pension Fund believes in emerging markets for accessing growth. Head of pensions, payment and support, Bob Claxton told portfolio institutional in April: “If you look at the demographic statistics about the population in China becoming industrialised and the number of people forecast to be born over the next 12 years and where they live – all of that is pointing towards economic growth, so ultimately our investment strategy should be pointing in that direction too. You do have short-term volatility, but the long-term trend is clear.”
Divergent opinions
Allocations to emerging market equities still remain low, however. The Mercer survey reveals that average allocations to emerging markets equities by European pension funds is just 5%; something Whiting believes is well short of a meaningful commitment. “We have UK pension funds that think they are punchy putting in 5% of their allocation but when you consider that emerging markets are 13% of MSCI world they are clearly underweight,” she says.
It is here that Hill and Whiting differ in their views. Hill says his clients are undeterred by the short-term stories coming from the emerging markets and are keen to plough on with allocations to the region. He also believes commitments will increase over time as investors become more comfortable.
“We are implementing a couple of emerging market equity investments right now. In a trustee meeting recently the participants were fully aware of what is going on and are still taking a five-year view that they want to have more into emerging market equities,” Hill says.
But Whiting is less convinced claiming pension funds are prone to pulling out of markets at the bottom. “Pension funds use very backward-looking models for allocation. A lot of them follow models that suggest a 3-4% allocation to emerging markets and that is because they are looking back on the performance and volatility of the last decade. It’s the nature of the beast; it’s what investors look at,” she says.
The frustration for Whiting is just how vast and diversified the emerging market universe is – there are more than one thousand stocks available to the JP Morgan team – and the scope continues to grow. In mid-June MSCI announced the addition of the United Arab Emirates, Greece and Qatar to the emerging market index and there is talk of Chinese A shares also joining the group.
“We have to try to encourage people to look through the short-term noise and recognise the development, growth and expansion we are seeing across the emerging markets. There is a lot of positive news to look towards but it’s getting that message across,” Whiting says.
The emerging markets are unpredictable but for investors willing to bare such volatility the long-term spoils are clear. Commentators believe the future is still bright and now is not the time to panic. “The emerging markets have young, growing populations with the possibility of increasing consumerisation and capital markets which generate superior returns to investors,” says Hill.
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