It is fair to say that the emerging markets have had a torrid year, facing the full brunt of investors’ continued changing sentiment fuelled by various macroeconomic risks.
This has largely been down to a shift in expectations of the US Federal Reserve, with chair Jerome Powell outlining there could be a need for further interest rate hikes above the current market expectations.
Emerging markets were hit particularly hard by the news, as it not only impacts certain countries’ current accounts, but would also have an impact on inflation, currencies and growth rates.
This has been coupled with a burgeoning trade dispute between the US and China – the MSCI Emerging Market index’s largest constituent – as well as country-specific risks in Turkey and Argentina.
All this has combined to send the MSCI Emerging Markets index falling, with the benchmark losing 12.94 per cent in sterling terms so far this year.
Performance of index YTD
Source: FE Analytics
Conversely, the US has held up much better – despite recent falls – with the S&P 500 index gaining 5.48 per cent – one of the few global equities markets in positive territory.
However, Jan Dehn, head of research at Ashmore Group, said that the time of strong growth in the US market could be coming to an end.
“The rise in US company costs exposed by the latest round of results is by far the most important change in the global financial landscape in the past couple of weeks,” he explained.
This is a serious issue, because cost-related problems are difficult to fix and the current US policy mix is, if anything, pushing costs up rather than down, Dehn noted.
If sustained, this could have a disastrous effect on global asset allocators, who have enjoyed almost a decade of expansion from the US market following the onset of quantitative easing (QE).
“Rising costs are now directly eroding earnings in some sectors of the US economy. If sustained, cost pressures will become more pervasive and could threaten the single largest consensus trade since QE began in 2010, that is, to be long US equities,” he said.
This, however, should be good for those invested in emerging markets, as the unwinding of QE will drive global asset allocation well into the medium term, the Ashmore head of research noted.
“Based on our estimates, emerging markets will be the big winner as the ‘QE trades’ unwind. This is because emerging markets were the only region to experience major outflows during the height of QE,” he said.
“Hence, as QE reverses, we expect developed markets to experience outflows and emerging markets to experience inflows”
However, he noted that – as most investors still regard the emerging markets as a peripheral investment – the bulk of flows as the ‘QE trades’ unwind could go towards European assets.
“We do not see how European or US assets can compete with emerging market assets in terms of risk-adjusted returns over the coming years,” Dehn said.
“Hence, the road less travelled – out of the QE-sponsored markets and into the non-QE markets, i.e. emerging markets – may well turn out to be the road more richly rewarded.”
Another conforming to the idea that emerging markets look like a worthwhile play is Peter Saacke, manager of the £156m Artemis Global Emerging Markets fund alongside Raheel Altaf.
Despite the pick-up in global volatility and the underperformance of the asset class, he said that there are reasons to believe that, relative to other regions, emerging markets do offer value.
“A lot of the issues that caused the deterioration in sentiment – worries of a trade war; the stronger dollar – are arguably now ‘in the price’,” said Saacke. “The dollar has stabilised and the Chinese central bank has added liquidity to the market, the effect of which we should see in the coming months.”
Indeed, the MSCI Emerging Markets index now trades on a forward price-to-earnings (P/E) multiple of 10.4x, slightly above the lows of August 2015 and early 2016 but still some way from its historic long-term average.
Value vs Growth by region using MSCI indices over YTD
Source: Artemis
“What these headline return figures and P/E multiples mask, however, is the recent outperformance of ‘value’ relative to ‘growth’,” he said.
Indeed, while value as a style has outperformed growth in all market regions since the start of this month – when the market corrected – in the emerging markets this has been going on since July, as the above chart shows.
“Perhaps that is unsurprising given the recent caution about the valuations of some defensive and technology stocks – and the rise in the oil price. But could it also signal the start of a long-awaited rotation away from growth and towards value?” Saacke asked.
In Artemis Global Emerging Markets, Saacke has an average P/E of 7.5x – an historic low relative to its history.
By country, the fund’s largest overweight positions are in China and Russia and its largest underweights are in the technology-heavy Korean and Taiwanese markets.
By sector, energy, utilities and construction lead the way while it has less exposure to the more widely-owned segments of the markets, such as technology and consumer goods.
“Looking ahead, we feel the fund’s discount to the market should stand it in good stead. In our view, emerging markets continue to offer access to world-leading companies, often at far more attractive valuations than in the rest of the world,” Saacke said.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
Artemis Global Emerging Markets has been a top-quartile performer over one and three years as well as since launch in April 2015 in the IA Global Emerging Markets sector.
This year, it has lost 8.36 per cent, less than both the sector’s 14.06 per cent fall and MSCI Emerging Markets index’s loss of 12.94 per cent.
The fund has a yield of 2.17 per cent and a clean ongoing charges figure (OCF) of 1 per cent.