CLEARPATH ANALYSIS – West’s persistent fiscal uncertainty helps emerging market equities become “safe havens”

West’s persistent fiscal uncertainty helps emerging market equities become “safe havens”
Published on   Jul 04, 2013

The search for yield in a constrained environment has caused significant rebound to emerging market equities, the Investing in Emerging Market Equities, report concludes. Over the last twelve months inflows into frontier equity funds have equated to roughly one quarter of assets under management. 1 But what drives this influx and how should investors isolate the appropriate geographies, governance and market volatility for best-value proposition.

The Investing in Emerging Market Equities, report, produced by Clear Path Analysis, in collaboration with M&G Investment, Allan Gray Africa Funds and Hermes Fund Managers debates how the West’s persistent fiscal uncertainty presents emerging market equities as “safe havens” for those with an increased appetite for risk.

According to Philip Gerson, Deputy Director, Fiscal Affairs Department, International Monetary Fund, “…many of them have paused their deficit reduction efforts in response to the weaker global environment.” But whilst an appropriate short-term response some “..emerging market economies still have fairly high debt ratios.”

Yet Gerson shares favourable economic predictions for 2014, particularly in more developed economies and argues that: “the gradual strengthening in advanced economies will be beneficial to emerging markets and low income countries in terms of increasing demand for their exports and commodity prices.”

Matthew Vaight, Fund Manager, M&G Investment, raises an important point regarding the state of corporate governance and influence of controlling shareholders in emerging markets: “In Brazil, China and Russia, for example, the state controls a large number of firms, enabling it to appoint personnel and direct corporate strategy. In China, 75% of the stock market by value is made up of state-owned enterprises (SOEs), in which the government retains a majority stake and exercises effective control.”

Vaight also stresses the diversity of governance within emerging markets. “In our opinion, South Africa has numerous businesses from banks to retailers that have exceptional operating practices as well as management teams that understand the importance of creating value for their shareholders and generate high returns on capital.”

Whilst conversely, he states: “there are markets such as Korea where companies are often controlled by families. These conglomerates frequently have complex and sprawling organisational structures and can be focused on empire building rather than generating returns for minority investors.” So carrying out the due diligence is vital particularly in those markets where it is questionable as to whether the management team is actually in control.

According to Andrew Lapping, Portfolio Manager, Allan Gray Africa Funds, the focus on emerging market equities should be on value not growth and that Africa in particular has good potential real returns. Lapping states “This is mainly because African equity markets are less developed, illiquid, under researched and often retail investor driven. These factors allow for discrepancies between the fair value of companies and their share prices to emerge.”

Lapping excludes South Africa in this as its “stock market has been a great place to invest over the past 15 years with returns of 13% per year, compared to nominal GDP growth of 10.3%.”

Lapping argues that market volatility, particularly on the African Continent, can make buying into negativity is a profitable strategy. “Kenya has a current account deficit problem (12% of GDP) and relies on foreign investments to settle the balance of payments. In 2011, a drought, among other issues, led to increasing inflation and a loss of confidence. The Kenyan shilling depreciated from KES85 to KES105/US$, while at the same time the Nairobi Stock Exchange 20 fell 18% in local currency terms, making for an excellent buying opportunity.”

Elsewhere Gary Greenberg, Head of Global Emerging Markets, Hermes Fund Managers, examines the value of Russia equities as an investment proposition. He asks whether “…the rest of emerging markets so unattractive as to make this modern pariah state look good in comparison, or are these specialists seeing something that others are missing?”

Greenberg states: “At the current earnings multiples (5x) it is more than one standard deviation under its historical mean (8x), and the discount to its universe of peers is 53%. Adjusting as one should for sector composition, the discount to the peers in Gems is 36%. Is this enough?” He believes it is.

On other geographies Lei Lei Song, Principal Economist, Office of Regional Economic Integration, Asian Development Bank, states: “We forecast Cambodia is going to grow about 7% in 2013 and 2014. It is a promising market. It has a good economic growth potential and a very strong demographic trend.”

“Myanmar is just starting to open up since late 2012. It is a frontier market and we predict its economy to grow about 6% in 2013. It has huge potential because it’s a very rich economy in terms of human resources, mineral resources, and it is also in a strategic position, connecting both South and East Asia.”


About carlarweir
I am a Cross Asset FIX Connectivity SME working for international banks. i also sit on the FIX Protocol Ltd Global Steering Committee, and am Co-Chair of the Global Cross Asset Committee. I also have a very strong background in Mobile Telephony, Cloud computing, SaaS, IaaS, PaaS, Big Data, innovation, and am a pioneer in Pseudolite technology.

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