Ask an investment professional for a top idea in emerging markets these days and you'll get quite a few exasperated sighs.
“My best investment idea in emerging markets at the moment is patience,” said Michael Power, strategist at Investec Asset Management, Cape Town, South Africa. “Investing at the moment would be madness. It's absolutely essential to keep your powder dry.”
The firm's emerging markets multiasset strategy has moved into safer assets, such as cash, U.S. dollar-denominated bonds issued by emerging markets governments and stocks of multinational companies that derive a considerable portion of revenue from emerging markets but are based in developed markets.
Mr. Power added that he'll look to invest in commodity-related countries, such as Brazil, Indonesia and South Africa, whose currencies and stock markets will rise sharply once global concerns over the eurozone subside.
Maarten-Jan Bakkum, emerging markets equity strategist, ING Investment Management, The Hague, the Netherlands, also is bearish on emerging markets stocks.
“I'm pretty worried about markets in general, so it's a matter of which is least bad,” Mr. Bakkum said. Pressed to pick a top country, he would choose Malaysia, which has seen less volatility than other emerging markets. “But the asset class as a whole doesn't look super attractive to me,” he said. “The European situation puts pressure on everything,” he explained. “It's very much a risk-off kind of moment.”
“The primary uncertainty right now is export demand over the next 12 to 18 months from Europe” and a possible flight of capital from emerging markets that could accompany a Greek exit from the eurozone, said Gary Greenberg, head of emerging markets equity at Hermes Fund Managers, London.
Hermes is emerging from its bunker after raising its cash position and dropping cyclical stocks in March.
“I don't think a fortress-type positioning is appropriate any more,” Mr. Greenberg said. “We're finding that the stocks most exposed to global growth have been hit the hardest and are now very attractive.”
Other managers are emphasizing the long-term growth potential of these markets and urging institutional investors to seize the opportunity to buy when prices are low.
“Our No. 1 investment idea as it relates to growth in emerging markets is that clients need to change their benchmarks and adjust to get exposure to smarter beta,” said Kathryn Koch, managing director and senior portfolio strategist at Goldman Sachs Asset Management, London. “We think a strong alternative is incorporating (gross domestic product) weighting into (global) benchmarks. The benefits are many.”
Working with Standard & Poor's Financial Services LLC, GSAM in March introduced its Global Intrinsic Value index, or GIVI, range of low-volatility benchmarks. GSAM is developing other non-market-cap-weighted approaches as well, Ms. Koch said, adding that institutional investors should be building their emerging markets holdings across asset classes.
“We're once again at the point where, like in the global financial crisis, there are some big, systemic risks in the developed world, that emerging markets are suffering disproportionately suffering from,” she said. “Tactically, with attractive valuations and strong fundamentals, it's a great entry point now.”
Yves Choueifaty, CEO at smart-beta specialist TOBAM, Paris, said market-cap-weighted equity strategies in emerging markets have an “incredibly high level of concentration.” TOBAM's “anti-benchmark” model provides maximum diversification, thereby lowering correlation to developed markets, Mr. Choueifaty said. “Emerging markets' correlation to developed markets is relatively low when you look at it from a market-cap-weighted perspective,” but you “almost double the diversification power” using TOBAM's smart-beta approach.
The following are some other managers' views.
Christian Deseglise, managing director and head of institutional sales in the Americas for HSBC Global Asset Management, New York; co-founder and co-director of the BRICLab at Columbia University: “The improving rating in macroeconomic fundamentals reflects itself more quickly and directly on the debt side than on the equity side.” Because emerging markets debt is less volatile than equity, the asset class makes a better entry point into emerging markets, and provides good diversification for investors already in emerging markets equity.
With current yields close to 6% and spreads over U.S. Treasuries of 430 basis points, emerging markets debt is “difficult to beat in the current environment.”
Jerome Booth, head of research at Ashmore Investment Management Ltd., London: “If you want returns, (emerging markets) corporate debt is where to go. It's hugely attractive in terms of yields.” The benchmark J.P. Morgan Corporate Emerging Markets Bond index non-investment-grade is yielding 8.63%; however, “one can do much better as the index is a long way from representing the full range of opportunities,” he said. Ashmore's strategy is yielding 14.12% year-to-date, but trails the benchmark over one- and three-year periods as of April 30.
Morgan Harting, senior portfolio manager in the emerging markets multiasset team at AllianceBernstein LP, London: “In our view, the best risk-adjusted returns in emerging markets can be generated with an integrated multiasset strategy rather than a single security or a portfolio of securities from a single asset class. Emerging equities are the most direct play on emerging markets economic growth, but traditional passive and active emerging equity strategies have higher volatility than developed equities. By using emerging (markets) bonds and active currency management as complements to emerging (markets) equities, investors can temper the risk of a pure equity strategy.
“In this way, they can retain exposure to emerging markets, capture the benefits of lower volatility and downside protection from bonds, and broaden the range of country exposures. Additionally, risk is often priced quite differently between emerging debt and equity markets, and this can be exploited to generate cheaper tail-risk hedges than would be found through traditional option strategies.”
Alper Ince, managing director and sector specialist for equity long/short at PAAMCO, Irvine, Calif.: “In emerging markets, we like Brazilian domestic consumption stories. In that area, we like penetration stories, such as education providers, which will really benefit from the demographics in Brazil.
“With education, the growth rates are substantial because the Brazilian middle class just emerged after years of growth.
“You're looking at (earnings) growth rates of 20%-plus on average.”
Todd McClone, portfolio manager at William Blair & Co. LLC, Chicago: Mr. McClone puts his personal money in his emerging markets small-cap strategy. “Our (quality growth approach) works particularly well in small caps,” he said. Regionally, he likes consumer- and property-oriented and financial companies in Southeast Asia — Indonesia, the Philippines and Thailand.
“In these countries, you have the opposite cycle as in the rest of the world” — that is, lending, economic growth and property appreciation are spiraling in the right direction.
James E. Craige, partner and emerging markets debt portfolio manager at Stone Harbor Investment Partners LP, New York: “The hard-currency sovereign debt market offers the best risk-reward to us.” Even though local currency bonds will probably outperform over the next three to five years, hard currency bonds are driven by both a tightening of spreads and by supply/demand issues — the tens of billions of dollars flowing into these investments is outpacing the issuance. “That's probably going to continue.”
Specifically, he likes Argentina. “It has a lot of volatility, but if you have expertise you should be able to generate alpha.” Politics keeps investors out of Argentina, but short-dated paper is yielding about 15%.
“We think there will be a 15%-to-20%-type of return from Argentine bonds for the next 12 months or so.”
David Bessey, managing director and head of emerging markets debt at Prudential Fixed Income, Newark, N.J.: He likes local currency sovereign bonds because there's been a rally in U.S. Treasuries, German bunds and Japanese government bonds, “but we haven't seen a commensurate rally” in their emerging markets counterparts. In hard currency, he likes Russian quasi-sovereigns, such as Gazprom and Russian Agricultural Bank. And he likes short-dated Venezuelan paper, which has yields of about 10%.
“The volatility we're seeing now is here for a while,” he said, so he likes either investments that will benefit from a flight to safety, such as the local currency government bonds, or those that benefit from the volatility like the Russian and Venezuelan ones. “It's more of a carry play, but we think that carry will work out for investors.”
David Dowsett, senior portfolio manager at BlueBay Asset Management, London: “To some degree, you can't take a view on emerging markets until you've worked out what's going to happen in Western Europe. Right now, not withstanding continued uncertainty in Western Europe, the case for (emerging markets currency-only strategies) is compelling.” Many currencies have been crushed by sovereign debt downgrades and technical factors and are 20% to 25% undervalued. He especially likes the Korean won. “That is a trade investors should take advantage of.” n