With a low Dollar, low valuations and recovering economies, these should be buoyant times for emerging markets, but buyers are thin on the ground.
- Over the past 12 months, the average emerging market fund is up just 1%, putting it below the Europe, Japan and North America sectors
- The benchmark MSCI Emerging Markets has become increasingly concentrated in a few high profile holdings
- There is a chance that buyers start to prefer China-only or Asia-only exposure
It should be a really good moment for emerging market funds. The Dollar is low, valuations are low and many developing countries have come through the Coronavirus crisis with their economies relatively unscathed. And yet it isn’t - investors continue to shun the asset class. Is it possible to see a brighter future for EM?
Over the past 12 months, the average emerging market fund is up just 1%, putting it below the Europe, Japan and North America sectors. Had it not been for the relatively strong performance of Asia – and China in particular – performance would have been even worse. The Indian and Brazilian markets have been lacklustre, with frontier markets such as Nigeria almost completely friendless.
This has had the effect that, in common with the S&P 500, the benchmark MSCI Emerging Markets has become increasingly concentrated in a few high profile holdings. In this case, not Apple and Microsoft, but Alibaba and TenCent. In the short-term, this may be a good thing – China, Taiwan and South Korea have emerged from the crisis in relatively good economic shape – but it changes the nature of emerging market investment over time.
There are signs investors are gently moving away from exposure to ‘global emerging markets’ as an asset class. Canaccord Genuity Wealth Management recently said it was rethinking its portfolios' exposure to emerging market funds, instead planning to use global and thematic funds to gain emerging market exposure. There is a chance that buyers start to prefer China-only or Asia-only exposure rather than trying to wrestle with Russia, or South Africa or other, less liquid and more problematic emerging markets.
Eventually this should create an opportunity. The weak Dollar has tended to prompt better economic and stock market performance from emerging markets. Valuations are still relatively low at a time when developed markets are looking increasingly expensive. Equally, emerging markets should emerge from this crisis with a lower debt burden, which should make growth easier to come by in future.
However, while many investors continue unimaginatively to prioritise technology and high growth companies, emerging markets aren’t likely to get a look-in. Equally, if political risk ramps up again – as it may if Donald Trump wins another term – investors may be disinclined to take developing market risk, no matter how cheap they are.
So this should be a good time for emerging markets, but it isn’t. Perhaps markets will start to appreciate their value once again at some point, but it is difficult to see a turnaround in the short-term.