Over three-quarters (16 respondents) of the 20 investors polled for this month’s Focus Group believe the recent underperformance of emerging-market assets has made them more attractive to their fund. According to a UK fund: “Emerging-market performance is still likely to compare favourably with developed-market performance.”
A Latvian fund said the “lower valuations/wider spreads are a more attractive entry point”, while a Belgian fund felt that “current underperformance is an opportunity to add more”.
Eleven respondents think the recent underperformance is due to market sentiment around the end of quantitative easing (QE) measures, and therefore just a short-term problem, whereas five blame longer-term, more structural failures to deal with dependence on foreign capital flows and domestic credit growth. One Danish fund blamed both, and a French fund agreed, saying: “The end of QE has been the catalyst [but] dependence on foreign capital flows remains a structural issue.” Another Danish fund expects a comeback for the asset class: “[I] don’t think the fundamental problems are as big as the market currently prices.”
Three respondents believe other reasons are to blame. One Dutch fund cited overvaluation of developed markets for the recent underperformance, while also pointing to overly optimistic domestic credit growth in some countries. “It may need several years to resolve, but is not a long-term phenomenon, in my view,” the CIO said.
Only one fund plans to decrease its emerging-market investments over the next five years, while 11 plan to increase and seven to keep their investment level about the same.
The expectation that emerging economies will grow faster than developed economies, and the diversification benefits they bring, are the two most influential reasons behind these investors’ decision to invest in emerging markets. They do not generally subscribe to the idea that the financial crisis has revealed emerging-market companies and countries to be ‘higher quality’ investments than their developed-market counterparts, and neither do they think that emerging-market assets offer good exposure to consumers in developing economies.
Four respondents regard China as the most attractive emerging country – “the disparity between rich and poor is lessening”, one UK fund noted – while India, Indonesia and Turkey are generally seen as the riskiest.
Half of those polled think that active management has always been very important in emerging markets, and will remain so. Three respondents feel it will become more important, while six think it will be less important. “As markets develop and expand they will behave in more representative ways that will allow indexing to more accurately capture overall economic drivers of return,” said a Swiss fund.
A Dutch fund offered a summary of its thoughts about the place of emerging markets in its portfolio. “The taper-buzz aside, emerging-markets equities did their job in 2013 – to be a diversifier. We have a longer-term view, and one year of returns distraction doesn’t alter [that] view.”
The 20 funds polled hold an average of 8.6% of their total portfolio assets in emerging-market equities, and 3.6% in emerging-market sovereign bonds. Just six respondents invest in emerging-market corporate bonds and three in other emerging-market assets.