Just when pension funds across the globe were getting comfortable with the idea of investing in emerging markets, their faith is being tested by disappointing performance.
The question is where performance in emerging markets — and institutional investments — go from here. Experts have different answers.
The long-term case for emerging markets is clear in the numbers: Over the 10 years through Nov. 30 the MSCI Emerging Markets index delivered an annualized 12.5% against 8.1% from the MSCI World index. Similarly, emerging markets debt has outperformed: The J.P. Morgan EMBI Global Total Return index returned an annualized 8.5% for 10 years through November, against 4.7% from the Barclays Capital U.S. Aggregate Bond index.
But more recently a combination of the previous uncertainty over when U.S. tapering of quantitative easing would begin — which led to sell-offs in early summer — a stronger U.S. dollar and muted economic growth relative to previous years have pushed emerging markets returns down in both equities and bonds. The uncertainty is muddying the waters when it comes to decision-making on keeping existing or putting new money into these investments. On the fixed-income side, the J.P. Morgan EMBI Global Total Return index underperformed developed markets, with -6.5% year to date through Dec. 19 vs. -1.9% for the Barclays Aggregate Bond index. But the MSCI EMI returned -3.6% this year through Dec. 19, significantly underperforming a 24.2% return in developed markets.
According to a 2014 outlook paper published by eVestment LLC, an institutional investment data and analytics provider, emerging markets equity strategies reported net outflows of $1.8 billion in the third quarter — the first time there have been net outflows since the fourth quarter of 2007. Yet emerging markets all-cap equity was the most-searched universe at eVestment through the first three quarters of this year, in terms of average monthly views and total monthly views.
“Emerging markets have seen a lot of volatility over the last year, and that has an impact on (investor) sentiment,” said Deb Clarke, London-based global head of investment research at consultant Mercer.
It is not just institutional investor sentiment that has been hit — experts, too, appear to be split on these asset classes, given low returns and valuations.
Money manager Schroders PLC is broadly cautious on the outlook for emerging markets.
“The domestic environment for most emerging market bonds remains challenging due to slow growth and rising inflation, posing a challenge to central banks,” said Matthias Scheiber, London-based fund manager, multiasset investment, at Schroders. The money manager has upgraded its view on emerging markets currencies, but is negative emerging markets bonds and “rather neutral on emerging markets equities,” according to Mr. Scheiber.
Schroders is avoiding U.S. dollar-denominated bonds due to an expectation of higher long-term U.S. interest rates and the additional carry for emerging bonds not able to offset higher rates. The manager is neutral on emerging markets equities as “valuation is not compelling despite the recent underperformance,” Mr. Scheiber said.
Despite the slowdown in emerging markets, experts say institutional investors have not completely abandoned their belief in the long-term opportunities. The eVestment all emerging markets fixed-income universe is expected to gain more than $50 billion in net inflows through next year, while emerging markets all-cap equity strategies are forecast to bring inflows of more than $20 billion in 2014.