Emerging market investors go to single-country allocations

Allocations to emerging markets as one homogenous region remains a largely unattractive bet, but some institutional investors and money managers increasingly are turning to specific countries or regions to try their investment luck.

Executives at consultants and money management firms said they are talking to institutional investors about adding to emerging markets allocations through single-country investments, with some evidence of money flowing into strategies.

“A number of pension schemes are entering single emerging market areas,” said Mauro Ratto, London-based head of emerging markets at Pioneer Investments.

And while sources acknowledged that interest in certain emerging market countries, based on recent good news, is cyclical, this time around there is an added force. “It is one of the consequences of the unconventional monetary policy that is dominating in the market. Indeed quantitative easing is pushing down rates in some cases into negative territory. Consequently, certain segments of investors are forced to look for better returns,” Mr. Ratto said.

“We have looked in some detail at this issue” of investing in specific markets rather than broadly, said Iain Douglas, New York-based head of emerging markets equity manager research at Towers Watson & Co. Clients with higher governance and asset size are showing interest in more niche emerging markets exposure, he said, while the majority of clients — where they have a dedicated emerging markets allocation — take a “very broad, somewhat active, exposure, which tends to look somewhat like the index emerging markets equity exposure.”

“We certainly find (specific country) ideas we think are interesting, but getting those into client portfolios is a real challenge,” particularly when it comes to having the governance necessary to monitor more managers, and having significant enough asset size to keep fees low, Mr. Douglas said.

Emerging markets as a whole have been suffering. The MSCI Emerging Markets index returned -2.38% in the month ended Nov. 10, and -10.74% year-to-date through Nov. 10. The MSCI All-Country World index gained 1.5% for the month through Nov. 10, but lost 0.14% year-to-date.

But sources at money management firms and institutional investors said bright spots are emerging, including Russia and India, and highlighted recent bets singling out specific emerging markets countries. The $296.7 billion California Public Employees' Retirement System, Sacramento, has built a $250 million position in Russia currency notes, and thinks a stable ruble might allow it to continue to purchase Russian bonds, according to Bloomberg. This month, emerging markets equities manager Charlemagne Capital Ltd. announced a new segregated emerging market equity hire from a Scandinavian pension fund looking to gain exposure in Latin American equities.

Data from provider EPFR Global show mixed signals from institutional investors using mutual funds, said Cameron Brandt, director of research in Cambridge, Mass. Data show between Sept. 1 and early November, South Africa, Poland, Brazil, China and Russia equity strategies attracted net institutional inflows. All emerging markets equity funds showed net inflows for most of October, but net outflows for the first week in November. Specific figures were not available.

While overall emerging markets equity funds attracted net inflows for eight of nine quarters, for the quarters ended March 31, 2013, to March 31, 2015, most single-country strategies in provider eVestment LLC's database recorded net outflows. When overall emerging markets equities recorded net outflows, of $6.2 billion over the three months ended June 30, those focused on Greater China, India, Korea and South Africa equities also recorded net outflows.

Some investors expect their money managers to set country allocations.

“It is highly unlikely that the fund would ever form a view on the attractiveness of individual countries/regions — that is what we pay managers to do, and would not claim to have the expertise to do it ourselves,” said Colin Pratt, investments manager at the £3.1 billion ($4.8 billion) Leicestershire County Council Pension Fund, Leicester, England, in an e-mail.

The $181.3 billion California State Teachers' Retirement System, West Sacramento, has been “feathering a little into emerging markets equities,” but thinks it is still too early, and is dominated by China right now, said Christopher J. Ailman, chief investment officer at the pension fund. “Emerging markets isn't a singular term — it is an amorphous variety of markets, regions and economies.” Mr. Ailman said there are “very individual opportunities; we have looked at Latin America private assets, but we still think it is a bit too early.”

But money managers said conversations have increased with institutional clients, regarding allocating to single-country strategies.

Andrew Benton, London-based head of sales, business development and client service — international at Baring Asset Management, said clients are engaging on and revisiting emerging markets allocations, which “includes single-market discussions where clients have a governance structure that allows them to consider specific regional allocations.”

India is emerging markets investors' “darling” right now, Mr. Ratto said. “India seems to be at country level more interesting, but it is a very difficult country to invest in when you embed valuations,” he said.

Aberdeen Asset Management's India bond strategy, launched a few months ago, has attracted $60 million to $70 million. “We are starting to see some client interest in specific strategies,” said Brett Diment, head of emerging market bonds in London. “There are lots of challenges in emerging markets, but India is one of the brighter spots.” He highlighted yields of about 8% in local currency terms, reform momentum, and the positive effects of the lower oil price.

PineBridge Investments is also seeing “substantially increased demand from investors for exposure to India, and in particular Indian equities, resulting from the significant market opportunity and growth prospects the country provides,” said Siddhartha Singh, head of client portfolio management, Asia equities, in Hong Kong.

And Christoph Hofmann, global head of distribution at Ashmore Group in London, said the market sell-off has created “some very attractive opportunities. Some clients (are) looking at regional or country-specific exposure. That is more common on the equities side.”

As for Russia, corporate debt up to five years out offers about 5%, said Sailesh Lad, London-based senior portfolio manager in AXA Investment Managers' global fixed income team. “Sanctions have been in place for over a year now, and the country hasn't shut down. It is in recession, has inflation, and the economy is weak; but corporates have been deleveraging. They have large cash balances. If you are looking at corporate credit and where to invest, Russian companies probably are some of the strongest names to invest in,” he said.

Pioneer finds Asia more interesting, despite the fact that bond and equity “valuations are not necessarily cheap ... but there are interesting countries such as India and China. Philippines and Indonesia stand out from a macro angle,” Mr. Ratto said.

Hermes Investment Management has been building up China and Taiwan exposure, said Gary Greenberg, head of emerging markets in London.