After three years of poor performance, senior European fund buyers and strategists are asking themselves if 2016 could possibly be the year when a little optimism might break out in emerging markets.
In cooperation with CityWire every quarter we ask several fund selectors across Europe their opinion on investment topics.
For some – although definitely not all – markets, prospects are looking a little brighter as headwinds relent. The MSCI Emerging Market Index fell by 34 per cent between 2013 and the start of this year, as tumbling commodity prices hit some countries particularly hard. The index has only had one positive year in the past five, massively underperforming leading developed market measures such as the S&P 500 index.
As Dídac Pérez, Director de Inversiones at Caja Ingenieros Gestión in Barcelona put it: “Falling commodity prices in particular have negatively impacted growth in many economies, especially commodity exporters such as Brazil, South Africa and Russia.”
On top of that, the much-needed Chinese transition towards a more consumer-based economy has been volatile. “This has impacted its own growth rate as well adding to the decrease in commodity prices,” Pérez said. “Debt has also risen consistently during the last years profiting from the lower financing costs in developed interest rate curves, particularly in dollars.”
But figures from the International Monetary Fund (IMF) see a recovery in average emerging markets GDP from a forecast 3.9 per cent in 2015 to 4.5 per cent in 2016 – more than twice the 2.2 per cent growth projected for developed markets.
However this is not a single story and the general belief that emerging markets were a pretty homogenized asset class is now and well and truly over. This is likely to become more pronounced this year.
Consensus Economics thinks that Latin American growth will recover somewhat feebly from -0.8 per cent in 2015 to 0.2 per cent in 2016. Its forecast for Eastern Europe is a little brighter – a move from -0.2 per cent to 1.7 per cent – but it sees Asia (ex-Japan) holding steady at a much brighter 5.7 per cent.
So Pérez is being very selective. “Tactically we now prefer to go long on those countries with current account surpluses [or low deficits] which benefit from low commodity prices and keep a market oriented reforms agenda,” he said. “So that leads us to Asia and away from LatAm and EMEA.”
For him, Brazil and Russia look difficult. “Politics remain stressed in those countries and investors will avoid them until more visibility is delivered,” he said. “There is currently a big divergence between countries and companies which are considered safe and those that are not. The valuation gap between them is increasingly becoming very large and is expected to remain so.”
At Paris-based Fundquest Advisor, head of research Isabelle Tillier and senior analyst Irina Pavlovici, are looking for countries that have good fundamentals and can raise their rates alongside the Fed, or countries that are commodities importers and so are benefitting from low prices.
The pair is keen on Turkey. “The collapse in energy prices has reduced its current account deficit which is good for its balance sheet,” says Tillier. “Companies are delivering strong returns even in the midst of geopolitical uncertainty.”
Luca Carlo Giovannone, a fund manager in the multimanager division at Symphonia in Turin, meanwhile is a fan of India’s economy. “From a long-term perspective probably it is the best candidate to take the helm of global growth from China thanks to its favorable demographics and its process of reforms,” he says. He thinks Mexico is another one to watch – he sees it as progressing well with structural reform with strong policy buffers so it can move its rates in line with the Fed.
Giovannone also likes Hungary and Poland, both of which, he says, have done a good job of dealing with their imbalances. “On a short term basis, the eastern European markets are the ones better positioned to profit from the recovery of Eurozone countries,” he says.
He also sees potential in some other Asiatic frontier markets. “Indonesia, Vietnam and the Philippines where valuations are acceptable and internal demand is growing very fast all show potential,” he says.
Brazil – not so long ago the bright shining star of Latin America – divides opinion as it readies itself for the Olympic games in Rio. The team at Fundquest is keen; in Tillier’s words, “Corruption and corporate governance are always hard to deal with but a bottoming in commodities in the second half might means that its equity and currency come back well”.
But Giovannone thinks that 2016 will be another hard year there. “While you can find good companies at bargain prices, the situation at the macro level is very compromised,” he said.
Of course when it comes to emerging markets, the overriding story always comes back to China. Its slowdown has been well documented and problematic and for 2016 the focus will be on whether China can successfully transition from an old industrial economy to a new consumer and technology led one.
“The market is very focused on China so as it continues to deliver decent growth, goes on with its transition and does not make intervention mistakes such as those occurred at the very beginning of the year, investors will turn to fundamentals again,” Pérez said. “But if any of these do not happen, we will experience more pain in 2016.”
One of the bigger question marks over China relates to its currency and the extent to which it will depreciate. The decision to switch to managing the renminbi relative to a basket of currencies is helping a transition to a more market led exchange rate but could also trigger a larger depreciation.
Overall then the outlook for emerging markets looks at least better than it did – but uncertainty has not gone away and investment plans have to remain nuanced. For Dídac Pérez, the big divergence between countries and companies which are considered safe and those that are not is his guiding principle.
“We strongly recommend taking a blend approach, investing in quality companies that can deliver sustainable growth over the next years but have enough discounts to make interesting returns in the future,” he said. “Those opportunities can be found also in countries that are currently out of favor.”
Luca Carlo Giovannone meanwhile also sees some room for optimism. “In the best case scenario global growth will prove resilient and that will bring with it some increase in the oil price, a bit of inflation and overall some relief on risky assets,” he said.
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