EM market turmoil is no game changer
Head of asset allocation
• Invested assets: SEK245bn (€28.1bn)
• Emerging market equity assets: c. SEK24.5bn (€2.8bn)
• One of five Swedish national pension buffer funds
• Date established: 2001 under the new system
We have invested in emerging market equities since the mid-2000s. At present, around 10% of our overall investments and one fifth of the equity portfolio is allocated to EM equities. Our strategic review from 2009 and more recent updates confirmed that we should continue to have a fairly large exposure to EMs.
At the peak, almost 13% of our total portfolio was invested in EM equities. However, due to unattractive conditions such as valuation and market sentiment, we have not added any new exposure since late 2010. Large flows of money went into emerging markets over the past years and due to the popularity of the theme we thought valuations got somewhat stretched, so we held back. We also had some concerns about currencies. Therefore, increases and decreases in our EMs exposure since 2011 have mainly been driven by market fluctuations.
The recent market turmoil that has unfolded was to be expected. Emerging markets are still vulnerable to both capital inflows and outflows. They do not have the same adaptability and internal market size that allows them to have a more fluent adjustment to asset prices and currency rates. Therefore, you have more extreme movements in prices. Our unhedged exposure only adds to the risk.
Our emerging market mandates are global in nature but have recently excluded South Korea and Taiwan, as we no longer support the idea that those two countries can be classified as emerging markets. Due to the exclusions, our EM assets today offer a purer form of exposure to economies that are still moving upwards in terms of economic development, market sophistication and depth of capital markets.
Emerging markets may not have rewarded us with an adequate risk premium over the last few years but over the longer term they have performed according to expectations. And the underlying story is still viable and the asset still attractive, in our view.
Emerging markets tend to come with national champions that are large in market cap and attract a lot of capital. However, they can also be more subject to national policies and the political considerations can cause setbacks in their profitability. We want to capture the real growth story in emerging markets by investing in smaller companies that provide new products and services to a public with increasing affluence.
Our investments in EM bonds are insignificant to date. We are most likely to increase our exposure to emerging market bonds, potentially also corporate bonds, but we have been fairly cautious so far.
René van der Zeeuw
Managing director, emerging markets equities
• Assets under management: €330bn
• Emerging market equity assets: c. €26bn
• Fiduciary manager of six DB schemes
• Number of participants: 4.5m
We aim to offer top-quality exposure to emerging markets by combining best-in-class external managers with our internal capabilities. Our internal strategies are placed against the high-conviction managers and high-alpha strategies we buy. In short, the fund is a combination of active, direct, in-house and externally managed strategies. We do not place single bets but instead find a balance between strategies that give us beta exposure, as well as stable alpha potential.
Our €26bn emerging market equities fund has been growing steadily over the last few years and the ambition our clients have expressed is to continue to allocate to this asset class and increase it to a certain extent in the coming three years.
The recent turmoil in emerging markets is definitely not a game changer in our investment view. Although it was a wake-up call for investors with high expectations who were banking too much on strategies such as domestic growth plays, it has no serious impact on our longer-term investment ideas with regard to emerging markets.
But it certainly led market participants to rethink their future investment strategies. If the Fed starts to taper, the cost of capital will increase and the cheap carry opportunities will have to be withheld.
A lot of foreign currency positions in current account-deficit countries, which were, to a certain extent, dependent on foreign money, are being unwound.
But when headlines started to appear about serious problems in emerging markets, EMs also started to outperform developed markets – not because of the tapering but because of positive economic data.
Investing in emerging markets is about investing in the longer term and not about investing in the short-term carry trade.
Our clients have been rewarded for investing in emerging markets over the past few years and we expect them to continue to be rewarded. Longer-term returns in emerging markets produced on average a 10% return over the past 10 years and that is also what we foresee on the long-term horizon.
The challenge in emerging markets is all about translating economic growth into corporate earnings and creating wealth for everyone.
We also have a separate portfolio for emerging market debt. There we can equally invest in hard as well as local currency and in government as well as corporate emerging market bonds.
Swedbank Pension Fund K3
• K3 is its and Estonia’s biggest DC pension savings fund and can invest up to 50% in equities
• Emerging market equity assets: c. €42.8m
• Invested assets: €428.3m (Sep 2013)
• Number of participants: 153,884
The K3 fund has had an exposure to emerging markets from inception, as Estonia itself was an emerging market until 2011.
We currently invest around 20% of the fund in emerging market equities, around 10% in EM bonds and 4% in EM private equity, the latter of which is allocated to the Baltics and Central and Eastern Europe (CEE) only. In total, 80% of our emerging markets debt risk is CEE related.
However, in equities we no longer have a bias towards CEE – the K3 fund, for example, only has an average 4% exposure to CEE, compared to almost 9% in developing Asia.
We do not run a global emerging markets strategy on equities. Instead, we have portfolios with a regional focus. We have a Latin America strategy, a Russia and Baltics strategy, a CEE, as well as a Turkey strategy and the developing Asia strategy. This approach has also been beneficial during the recent turmoil in emerging markets. We preferred placing regional bets rather than pulling out of EMs. Our favourite bet since mid-summer has been overweighting Russia at the expense of Latin America.
But the volatility and risk is part and parcel of investing in emerging markets because all of those countries are going through different cycles in their development speed. We are monitoring the equity markets bearing this in mind.
We expect emerging markets to outperform their developed counterparts to some extent in the future but perhaps not at the same rate that was expected in the past. In short, we are cautiously optimistic over the long term, despite the poor performance over the last four to five years on EM equities.
However, we are satisfied with the premiums we have generated in fixed income. Our emerging market government debt portfolio, for example, returned over 19% in 2012, while this year it has been moderately positive.
Over the long term we plan to increase our overall exposure to emerging markets but we will do this on a step-by-step basis only. We will also continue with our regional strategies.
We invest in emerging market equities portfolios through exchange-traded funds and actively managed funds. In fixed income, we prefer to invest directly in hard currency government securities. However, from time to time we place tactical bets on emerging market hard currency corporate debt and in that case we invest through funds.
We also exclusively invest through funds in our emerging markets private equity portfolio.