The term “Emerging Markets” was first coined by Antoine van Agtmael, an international investment manager, to highlight the potential of the companies and the stock markets that were emerging out of less economically developed countries of the world. Broadly, Asian countries such as China, India, Korea, Indonesia, Malaysia, Thailand along with Latin American countries like Argentina, Brazil and Europe Middle East African (EMEA) countries like Russia, South Africa, Turkey fall into the Emerging Markets (EM) group. Due to their high growth prospects and better investment returns, the developing economies such as India have attracted the attention of investors, worldwide.
In this piece, we evaluate the potential and the investment opportunities that exist in countries apart from India.
The global credit crisis, which left the major financial centers with bankruptcy issues or heavy losses, has crippled the growth of several economies from the developed world. While the advanced nations are striving to squeeze out growth amid low interest rates and easy liquidity, the emerging markets have managed to maintain their momentum and recovered impressively. With higher savings rate, the share of household and mortgage debt to GDP is lower in EM than US or Euro-zone (source: Schroder, 2010). Despite the fears of double dipped recession, as per 2012 IMF forecasts, EM are expected to grow at 6.5% and the output for India and other Asian majors are projected at 8.6%. However, the attractiveness of EM has been undermined by the sequential increase in interest rates by the central banks (RBI, in case of India) to control inflationary pressures. Though, GDP is not a concern, managing risks arising out of capital inflows and inflation are some of the issues faced by most EM countries.
Olivier Blanchard, Economic Counsellor at IMF states, “For the recovery to be sustained, advanced economies must achieve fiscal consolidation. To do this and to maintain growth, they need to rely more on external demand. Symmetrically, emerging market economies must rely less on external demand and more on domestic demand” (source: World Economic Outlook, April 2011).
Thus, countries such as India who have a large population base with rising disposable income and robust consumer spending can sustain their growth figures. The pace may slow down if global as well as local macro-economic conditions continue to deteriorate.
The MSCI Emerging Market Index which is roughly composed of about 20 global emerging countries has seen an upward march in the last decade (between April 2001 and March 2011), giving a CAGR of 14.28%.
Though, as seen in the chart 1, the index has tumbled in 2008; this was an outcome of the risk aversion amongst international investors who assign a higher risk rating to emerging markets vis-à-vis developed markets.
Furthermore, the chart 1 shows the MSCI World Index, which comprises 24 developed countries, has had a flat run in comparison to the MSCI Emerging Market Index. However, the global emerging markets are subject to intermittent volatility; in the first half of 2011, these markets were down by about 0.5%.
Notably, each of these countries has exhibited extreme performances in the past. For example, Russia was the worst performing market in 1998 with -84% returns but, bounced back next year returning 285%. Even the markets in India have been subject to sharp performance trends. BSE Sensex fell from a high of 20,235 points to 9647 points at the end of 2008. Subsequently, the index touched 20509 points at the end of 2010, almost after two years. Thus, investors need to be patient with their holdings in EM Funds.
Chart 1: 10 Year Trend
source: Bloomberg,iFAST Compilations
Factors that matter
The sharp fluctuation in commodity prices is reflected pertinently in MSCI Emerging Market Index which has 25-30% weightage to energy and materials sector. Historically too, EM countries have shown strong correlation to rise and fall of commodity prices. While Brazil and Russia seem to benefit from the rise, India and China which are dependent on commodities to fuel their growth suffer from inflationary pressures. Apart from this, locally, an increase in food and fuel prices would negatively affect the consumption in EM particularly, the urban poor and middle class.
The capital inflows to emerging markets have also influenced the return potential. For instance, India equity markets were weak in August 2011 touching close to 16,000 market levels, as Foreign Institutional Investors sold equities worth 10,000 crores, the highest outflow in CY2011 (source: ICICI Prudential AMC). In the past, the loose monetary conditions in the US due to quantitative easing I and II has resulted in flush of liquidity towards the faster growing economies driving up the stock indices. Therefore, the global events do impact the flow of the money into EM. Hence, the sensitivity of EM Indices to global macro-economic scenario cannot be ruled out.
Due to poor investor sentiment, the equity markets have undergone a correction in 2011.
According to iFAST Research, several markets are at a single-digit PE ratio presently based on Forward Earnings for 2013. The view is, “While we expect earnings to be negatively impacted over the near-term as economic conditions deteriorate, the sharp declines in equity markets year-to-date have more than offset the expected decline in earnings, resulting in depressed (and hence, very attractive) stock market valuations. The steep declines have raised our expected return on equities, and we consider the asset class more attractive compared to the beginning of 2011.”
In addition, iFAST Research opines, “While most of the economic concerns stem from developed economies, emerging markets have also been sold down on contagion concerns. Given the stronger economic fundamentals of emerging markets and monetary flexibility, we expect them to weather the anticipated slowdown in developed economies and post a strong subsequent recovery, Emerging markets will likely post stronger economic growth compared to their developed market counterparts, which should imply higher rates of earnings growth and stronger stock market returns for the region.”
On China, Mirae Asset Management (2 September 2011) states optimistically, “The Chinese market is currently trading at a PE multiple of 9.52 vis-à-vis the average 5 year PE multiple of 13.7 (30% discount to 5 year average). The market has priced in negative news and with the macro indicators improving the investment risk reward at current valuations look favorable.”
“Over the past 18 months earnings forecasts in India have been cut more decisively than either for the broader Asian or global emerging markets. As a regional manager, we see that Indian earnings projections have turned more realistic and are much closer to the bottom versus their Asian/EM peers,” shares JP Morgan Asset Management on India.
HSBC Global Asset Management holds a positive outlook on Brazil as the country continues to trade at relative attractive multiples - 12 month Forward P/E stands at 10.0X while EM, China and India trade at 10.4X, 10.7Xand 13.8X times respectively (as at June 2011).
Overall, most of the EM are currently attractive from a long-term investment horizon.
Emerging Market Funds
Should Indian investors put their money into other emerging markets?
As Dr. Shane Oliver, Head of Investment Strategy and Chief Economist at AMP Capital Investors states, “The key lesson (from Global Financial Crisis) seems to be that emerging countries remain coupled to the global economic cycle, but can continue to outperform over time.”
Thus, EM can be related to the presence of mid-cap companies in a broader market index. Just as, the mid-cap and small-caps which are attractively valued and have growth potential, can beat the broader market in the long term, EM represent the rising superpower group of tomorrow. A fund manager’s skill lies in identifying the right composition to create wealth for its investors.
From an individual’s perspective, aggressive and moderately aggressive investors having a long-term investment horizon can consider partial allocation to EM Funds.