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Investors have thrown ‘the baby out with the bathwater’ in emerging markets
Emerging markets have underperformed their developed market peers for more than 10 years, leaving investors “quite disgruntled, quite upset, quite traumatized”. That’s partly due to an almighty bubble that’s been pumped up by easy money and speculation in tech companies – but China’s regulatory intervention and the war in Ukraine didn’t help things either. Still, there could be good news around the corner.
“When you see that sheer distress and emotion creep into a situation, that tells you as a rational investor that things are beginning to look more interesting,” says Archie Hart (pictured), portfolio manager for the emerging markets equity strategy in the 4Factor team at Ninety One. “We’re beginning to get to a place where things may begin to improve.”
“In many ways investors have thrown the baby out with the bathwater, and the bath, and half the bathroom and the house as well. But there are a number of very positive things in emerging markets, with monetary tightening much further advanced, valuations much lower and economies less correlated with the rest of the world”.
The emerging markets have seen very aggressive monetary policy compared to the developed markets, where some of the adjustment has barely started; they’re already a long way through the pain. The next move in interest rates in some parts of the emerging markets may well be lower, and that’s “quite beneficial for putting a floor under markets”.
There’s still probably going to be a recession, and that “sounds like a bad time to be invested in any market”. But the EM set tend to do better than their DM peers in that market. They sell-off more aggressively and get more depressed, but they recover a lot faster.
“It’s been a more anemic emerging markets versus a pumped-up, bubbly developed markets,” Hart says. “One of the positives for EM equities is that some of the air comes out of the bubble in some DM equities and that’s beneficial and that’s making EM more attractive in comparison because we haven’t really had that.”
“If you look at Indian property values, for example, they haven’t moved over ten years. If you look at the dividend yield in the market it’s at 10 year highs in emerging markets. So you’re looking at quite a cheap asset class without some of those pressures we’re seeing in developed markets.”
Still, it takes a lot for most investors to get comfortable with the emerging markets. The ghost of Xi Jinping’s regulatory intervention in China’s technology and education sectors still haunts institutions who had allocated heavily to the world’s second largest economy, and they’re scrutinising any country where similar risks might rear their ugly heads.
“It’s not about the governance of the country; it’s the governance of the company you’re invested in,” Hart says. “Very often when we’re investing in EM we’re a minority shareholder to a family or a group. You have to figure out whether these people are aligned with you and they’re going to give you a fair crack of the whip and they’re looking to grow the pie rather than just their slice of the pie. Those things are critical.”
Within that broad emerging market space there’s a lot of room for really good managers to add value. In India, we invest in the number four hospital company; it only has 20 hospitals, and there’s a lot of room to grow. We have one of the top five property developers in India; it’s an enormous country, and the company is only a couple of billion dollars in size. We can see how it might be several times that size in the longer term. There’s a lot of risk, but there’s a lot of opportunity.”
