In addition, recent estimates from NN Investment Partners which were based partly on recently-released official data show the total net outflows from the 15 largest emerging markets totalled a hefty $600.1bn over the three quarters to the end of March. This was higher than the $545.2bn of outflows seen during the crisis- ridden nine months to the end of March 2009.
GREEN SHOOTS
However, it is not all doom and gloom. Blackrock’s latest report noted that emerging market ETFs garnered inflows in May for the second month in a row, at $2.7bn.
Fears have also lessened about the impact of the imminent rate rise in the US which, although delayed due to weaker than expected economic data, is expected to happen by the end of the year. Not only is the event priced into the markets, but divergent monetary policies between the US and Europe as well as Japan means that the cyclical swings or the large capital flows which typically occur from emerging markets to developed nations are likely to be less.
Equally as important, valuations look tempting. The forward price-to-earnings multiple of the MSCI EM index is hovering around 11.6-times versus the 19.8-times of the MSCI World. In fact, according to data from Unigestion, the valuation premium for developed market equities over emerging markets is currently at its highest since June 2004.
UNEARTHING OPPORTUNITIES
Finding the right prospects, of course, is not an easy task. As Bernard Nelson, senior investment consultant, JLT Employee Benefits notes, the active approach does make more sense than the passive, but relies on the skill of the manager to buy at the right time and avoid the bubbles.
“There are also the risks such as weak corporate governance and the fact that many companies still have families that have a large shareholding interest,” he adds. “They want to keep control and this can be a bit of a minefield. From our experience, most funds go for a relatively small allocation. For example, if equities accounts for roughly 50% to 60% of the total portfolio, around 5% to 10% will go into emerging markets.”
Most active managers are bottom-up stock pickers who spend time crunching the numbers and meeting the management.
“When you invest in emerging markets, you are looking at what these countries will be in the future using developed markets as a roadmap,” says Peck. “It is also important to realise there are significant dispersions across countries and sectors. For example, if you look at year-to-date performance for the end of April, China was up 26% while India was down 1.5%.”
Although managers will differ in their approaches, Peck believes the best way to gain exposure is to take a broad view.
“Small caps are an interesting place and they can outperform in different economic environments,” he says. “However, we invest across the cap universe because it expands the opportunity set and gives greater breadth and depth. Conservative investors typically prefer larger caps because they offer more protection, but small to mid-cap bring greater diversification. Overall we have greater exposure to consumers and industrials because we think these sectors offer the best long-term performance opportunities.”
Bruno Taillardat, investment director at Unigestion, also takes a comprehensive view.
“We do not have strong restrictions in terms of market cap although have a slight bias towards mid-caps,” he says. “Our goal is to choose stocks that can help us diversify, are exposed to the full premia and have lower volatility and drawdowns.
“Our strategy is to look at the risks we will not be rewarded for, the macro-economic dynamics to ensure that we are not investing in countries with weak growth and the valuations to make sure we are not overpaying. We have exposure to countries and sectors with interesting dynamics such as IT in Taiwan and telecoms in South Korea as well as IT in India where Prime Minister Narendra Modi is making good progress with his economic reforms.”
Russell Investments also pursues an all-cap strategy with a quality tilt to mitigate the risks of liquidity and limited research coverage, according to Kathrine Husvaeg, head of emerging market research at the firm.
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