While emerging markets are facing a short-term impact from the Wuhan coronavirus outbreak, investors should not be put off investing in the region for the long-term, according to GAM Investments’ Tim Love.
Love, who manages the $1.5bn GAM Multistock Emerging Markets Equity fund, said there are still a number of drivers supporting emerging markets in the long-term and that active managers are best-placed to take advantage of them.
“It is our view that emerging market equities are one of the more challenging investment areas for passive strategies to mimic,” said Love.
“Traditionally, many passive emerging market equity strategies have struggled to match MSCI Emerging Markets index returns for a number of reasons, not the least being the level of corporate actions and corporate fraud.”
As the below chart shows, the average FE fundinfo-rated passive emerging markets strategy has significantly underperformed the benchmark over the past decade.
Performance of sector vs index over 10yrs
Source: FE Analytics
The GAM manager said active management in emerging markets offers ample opportunities for reversion to the mean both from a top-down currency perspective and from a bottom-up stock level due to the inherent volatility of the asset class and the wide range of countries within the universe.
As such, Love highlights below 10 ways that an active allocation to emerging markets can benefit investors.
Dollar peaking
The US dollar is a key currency for emerging market economies as many of their currencies are pegged against it and debt issued in the currency.
As such, any strengthening has a significant impact on emerging market assets as has been seen since the start of the year.
Nevertheless, Love said that over the long-term slowing global growth and any normalisation of rates by the Federal Reserve should lead to more constrained dollar strength and benefit emerging markets.
Attractive entrance points
“It has been a historic decade of emerging market equity de-rating versus developed market equities,” said Love. “Lower realisable earnings per share growth, plus the ramifications of a strong dollar, led to a decade long de-rating/underperformance versus the developed world and especially the S&P 500.”
As such aggregate investor positioning now looks “too defensive”, said the GAM manager as the long-term prospects and near-term cyclical trends have improved.
Valuation re-rating
Indeed, Love said that emerging markets allocations are now supported by a strong valuation and re-rating argument.
The manager said that the valuation gap between emerging markets and those in the developed markets is too wide, particularly as earnings per share are showing “strong signs of life” compared with underperformance of the previous decade.
Carry trade
Analysis by GAM suggests that most emerging market currencies are undervalued, said Love, and as such the carry trade could become an attractive prospect for more longer-term investors.
“As the cycle shifts in favour of cyclical plays due to a pick-up in global trade and the increase in risk appetite of investors, we believe emerging market FX gains should be positive this year,” the manager added.
Superior growth
Forecasts by the International Monetary Fund suggest that growth in emerging markets will accelerate in the 2020s, due to improved fiscal economic and monetary strategy and structural reforms.
In addition, Love said easier financial conditions from synchronised monetary easing across emerging markets should have positive effect on growth.
A laggard rate cycle
Last year, said Love, 15 emerging market central banks lowered interest rates by an average of 100 basis points, a larger cut than the US federal Reserve.
“These markets, on the whole, have further ability and potential to ease further, contrary to most major developed economies, since inflation remains benign,” he said. “Also, in the years to come, we believe the global economy is likely to depend on emerging markets for more diverse growth sources.”
Emerging markets tech impulse
“We believe e-commerce, digital banking, artificial intelligence, autonomous driving, robotics, ‘Internet of Things’ and mobile computing will all be fundamental drivers of emerging markets for years to come, signalling strong longer-term prospects,” said Love.
Asian companies are already challenging their western counterparts and in next-wave technology and these ‘leapfrog’ technologies should benefit people in emerging markets more than in the developed world.
Improving ESG standards
The focus on environmental, social & governance (ESG) issues has intensified in recent years and has been felt in emerging market through scoring.
“Whether it is the globalisation or ubiquitous adoption of social media (even through fire walls), the phenomenon of global norms continues to permeate to emerging markets economies’ perception of ‘best current practice’,” added Love.
Ongoing domestic reform programmes
Authorities in emerging markets, such as Brazil and India, are increasingly undertaking reforms to help develop their economies, root out inefficiencies and attract foreign capital.
“The recent reduction in corporate tax rates, key focus on infrastructure development, measures to improve the regulatory environment and monetary easing will likely steady these economies,” said Love.
Secular supports
Finally, Love said there remains a lot of secular support that has been largely unrewarded during the past decade.
This has included supportive GDP per capita growth, demographics, urbanisation, female job participation, speed of industrialisation, and producing more of the tech disruptors and ‘leapfroggers’.
“Secular growth is more attractive than ever in a low growth world,” he said. “We believe this can equate to circa 3-7 per cent in additional potential long-term earnings per share.”
Performance of fund vs sector & benchmark over 5yrs
Source: FE Analytics
Love has managed the GAM Multistock Emerging Markets Equity since February 2015. Over the past five years it has made a total return of 57.06 per cent outperforming both the MSCI Emerging Markets (50.44 per cent) and IA Global Emerging Markets (45.24 per cent). It has an ongoing charges figure (OCF) of 1.10 per cent.