All about timing for emerging market investment

Emerging Markets, September 2011

International investors are wrestling with timing over emerging market investment. Most  believe emerging markets offer the greatest opportunity in world investment today, but those markets continue to be hit by volatile reversals in light of problems in the developed world.

“I would expect emerging markets to sell off – not necessarily because their fundamentals have come off, but because the big demand for emerging markets is from crossover investors,” said John Cleary, CEO and CIO of emerging market-focused hedge fund Focus Capital. But he said he was “buying into the selloffs in equities. If you look at valuations, they are at near five to eight year average lows. There are really compelling valuation stories, growing domestic consumption and changing trade patterns.” On the debt side, he said he expected “increased allocation to emerging market debt, there’s no doubt about that.”

This sense of short term declines but long term value is prevalent across the investment community.  “In the short term emerging markets – both debt and equity – are vulnerable to further weakness in advanced countries,” said Shane Oliver, head of investment strategy and chief economist at AMP Capital Investors. “This is being reflected in cautious capital flows to them. However over the medium term, the absence of debt problems and stronger growth potential indicate that emerging markets are the way to go for investors.”

The more common view is that debt will enjoy revived flows before equities. “In fixed income, capital flows in Asia have been more consistent than in equities, and positive,” said Neeraj Seth, managing director and head of Asian credit at Blackrock. “I believe over the long term that will continue. The only risk is in the short to medium term: There could be small patches of reversal, as you are seeing now, and that’s something you’ve got to be mindful about.

“I would still be positive in the long term for Asian debt, especially for countries with good growth and strong and improving sovereign balance sheets.”

But strategists argued that investors will need to see a clear floor in declines before they return en masse, suggesting we may see further outflows before the longer-term trend of capital movements towards Asia return. “There are only two reasons for any investor to look to pick the bottom in the emerging market world now: confidence that the emerging market economies will survive the global downturn, and that rate cuts would be forthcoming,” said Woon Khien Chia, strategist at RBS in Singapore. “The assumption here is that there would not be a repeat of a global banking crisis a la Lehman, which is a very strong assumption at this juncture. There is no clarity now on how the Greek debacle will eventually unfold. Hence, we may see more sell-off before the smart money returns to the emerging markets world.”

Timing this return will be crucial to the investment management industry. “Emerging markets have cheapened, and are pricing in more of a global crisis, but it is a moving target: it’s like a dog chasing its own tail,” said Pablo Goldberg, head of emerging market research at HSBC, adding he would “certainly back fixed income, net equities.”

Cleary added: “To a degree, I think a big part of the panic and flight to cash has already happened. The overriding sense is that investors are comfortable with increasing their allocations to emerging markets despite the volatility. Asia is not immune, but it is far more resilient than it was in the past.”

Longer-term, there seems little doubt that enthusiasm for emerging markets will resume. The Blackrock Investment Institute said last week that emerging markets represent 86% of the world’s population, 75% of its land mass and resources, but just 12% of global equity market capitalization. “The emerging markets’ share of world financial assets will increase materially over the next decade,” it said.