Dehn says investors were too quick to jettison exposure to emerging markets last year. He says another sell-off is likely and that investors should use it to buy back into the contentious asset class on a long term view. “In May 2013 when the chairman of the Fed Ben Bernanke announced tapering of quantitative easing the market had one of its usual knee-jerk reactions,” he said.
“Investors reverted to a clichéd rule of thumb; sell out of emerging markets and buy the US,” he said.
“Recently we have seen the classic risk roll-down. The market freaks out and then begins to recover and investors tip-toe back in and by buying back in to the safer assets and as they get more comfortable they will buy the more risky ones.”
“However, there is likely to be another correction in the near term as quantitative easing is further unwound but this will be caused by investor panic rather a change in fundamentals and will be of a lower magnitude than in the previous year.”
“We bought into the last sell-off but we won’t be selling any as liquidity in emerging markets tends to be highly pro-cyclical.”
“The underlying investment fundamentals have not changed and remain attractive.”
Emerging markets have steadily underperformed developed markets over the past few years, but have been mostly out of favour in the past twelve months after suffering sharp sell-offs in May 2013 and January 2014.
Investors poured money out of the asset class after the Fed began to hint it would reduce its monthly stimulus program and raise interest rates in May of last year.
This raised fears that emerging markets would be due a period of underperformance after several years of cheap money coming to an end, deflating asset prices.
Dehn says investors incorrectly believed that emerging markets had disproportionately benefitted from quantitative easing.
“This notion is nonsense. Emerging markets have not gorged on cheap money,” he said.
“In fact, developed markets have benefited more and are more addicted to the cheap money created by QE than emerging markets,” he added.
Since the Fed started to hint that it was planning to taper its quantitative easing program the MSCI Emerging Markets index has lost 7.11 per cent compared to rises in the developed market indices in Europe, the US and UK of between 5.6 per cent and 7.3 per cent.
Performance of indices since 22 May 2013
Source: FE Analytics
The performance of emerging markets has been a lot stronger in 2014, and they have outperformed developed markets over the past three months, unaffected by the April market correction that saw double digits wiped off the share price of developed market technology and biotechnology stocks.
The MSCI Emerging Markets index has risen faster than developed markets over this period, rising 7.98 per cent, whereas the S&P 500, FTSE All Share and MSCI Europe all rose less than 4 per cent over the same period.
Performance of indices over 3 months
Source: FE Analytics
Dehn remains bullish on the outlook for emerging markets over the longer term but says some risks from the withdrawal of QE persist in the medium term.
He says the long term case for emerging markets remains in place due to the convergence of per capita GDP between emerging and developed economies.
“Structurally emerging markets are pretty well positioned going into the taper; there markets have not been overbought and they haven’t gorged themselves on cheap credit. However, there is no doubt that financial tightening will cause major differentiations across countries.”
“Having said that; access to international capital will become increasingly important and the behaviour of investors that facilitate this will also be very important.”
“A number of countries will open up to global capital and others will not.” “Investors need to remember that there is a huge difference between emerging markets countries but every time there is a sell-off they tend to get lumped together, as if Guatemala was the same as China.”
“The most advanced of all of them is China. No other country on the planet is positioning itself for the world of tomorrow than China.”
Smith and Williamson’s Richard McGrath recently told FE Trustnet emerging markets were at the perfect entry point after their recent falls amid central bank, currency, and political fears have with inflows rising and valuations have bottoming out.
“We are already starting to see the tide turn a bit in emerging markets despite the negativity that has been thrown at them in the first quarter of 2014. This is an inflection point providing a very good entry point into the asset class,” he said.
