Investors turn to emerging markets
Emerging market funds may traditionally have been an area where only the boldest investors dared to venture, but that perception is changing. From Latin America to Asia and Eastern Europe, recent returns have been impressive, with some funds registering gains well above 100 per cent over the past two years.
While such a performance obviously catches the eye, the more significant factor is a subtle shift in the underlying balance of economic power. Countries such as China, India and Brazil may be classified as developing, but their strong export sectors and burgeoning consumption is obliging investors to look at the world through a different lens.
'Emerging markets are in better shape than for the last 10 to 20 years,' said Geoffrey Wong, head of global emerging markets and Asia ex-Japan equities for UBS Global Asset Management. 'Most are running current account surpluses and are now net lenders to the developed markets.'
He noted that while this represented a big turnaround since the 1980s, it did not mean emerging markets were immune to shocks.
'But when shocks occur, they are likely to be smaller in magnitude than before,' he said.
Mr Wong sees particular value in Brazil, Russia and Thailand. He regards Asia as the most attractive region.
'It has not appreciated as much and is relatively a laggard,' he said.
Even so, the firm's Greater China fund was up 73 per cent last year and 126 per cent over two years, benefiting from major inflows from the United States, Europe and Japan.
'International investors don't think China shares listed in Hong Kong are expensive, so there is still value there.'
In Mr Wong's opinion, infrastructure and consumer-related plays were good long-term bets. Developing countries with new-found wealth from energy and export earnings would be spending on infrastructure. Construction companies and suppliers around the region were sure to benefit.
'We see the potential in that as huge,' Mr Wong said.
Companies linked to the consumer theme held similar promise. Particularly in Asia, they stood to benefit from three things: a relatively young population, the low level of personal debt, and the likelihood that, going forward, rates of consumption would outpace gross domestic product.
At present, Mr Wong preferred to be underweight in energy and materials, including iron ore and steel, believing that new production capacity coming on stream would limit upside potential.
He said that UBS policy was to buy into attractive companies of a practical size with good quality management.
'That applies across all markets,' he said.
To obtain information, the firm does extensive on-the-ground research. For example, fund managers and sector analysts will visit energy installations in Siberia before buying into a company like Gazprom. They also consult widely with industry experts, academics, politicians and former generals to get better than consensus data and see if 'the story pans out'.
'With emerging markets, portfolio managers must have a feel for the quality of the information and the level of uncertainty,' Mr Wong said. 'If we don't think we can get a reasonable [understanding] of the company, then we won't take a position in it.'
One of his basic principles was to study cash flow, assets and operations as if buying the whole company. Fundamentals were what counted, not trying to predict short- to medium-term stock price movements.
Singapore-based Rachana Mehta, head of Asia and emerging markets for DBS Asset Management, is also seeing good returns from developing economies.
For the firm's Asia bond fund, which saw growth of more than 50 per cent in the past year, she focuses mainly on sovereign bonds denominated in local currencies. As an absolute return fund, there has been a consistent, positive performance in terms of both currency appreciation and yield since it was set up in 2005.
Ms Mehta includes countries from South Korea to Indonesia and recently added Sri Lanka and Pakistan. Two developments prompted this move. The first was Sri Lanka's decision last year to allow foreigners to buy into local currency government bonds offering up to 5 per cent of the outstanding issues. In addition, the five-year government bonds offering about 15 per cent were very attractive. The second was Pakistan's expected GDP growth of 5 to 7 per cent and increasing overseas investment in the country's banking, oil and gas sectors.
'Pakistan sovereign bonds in US dollars give a yield of about 7 per cent,' Ms Mehta said.
'There is some political uncertainty, but we do believe once the [coming] election is over we will see funds flowing back into the market.' She said that nagging concerns were the possibility of a spike in inflation, especially in the United States and China, and labour costs picking up across the region.
'But overall, people are very bullish in Asian currencies,' she said. 'The Asian governments and corporates have moved away from dollar borrowing and are borrowing domestically and the medium-term perspective is good on account of the liquidity within Asia.'
Ms Mehta also manages an Indochina fund, set up in March, which concentrates on Vietnam bonds and equities. The balance is now 70-30 in favour of bonds, but will progressively switch in the next two years as more companies list on the Vietnamese stock exchange.
She pointed to the country's GDP growth of about 8 per cent and a steadily strengthening currency as reasons for optimism, and is already weighing up prospects in Cambodia, Laos and Myanmar.
'Cambodia is looking like the next market,' she said. 'It may become attractive in sovereign bonds in the next two years.'
Despite the current rates of return and generally greater transparency in most emerging markets, Mr Wong of UBS nevertheless sounded a note of caution.
'Trees don't grow to the sky and these markets won't always go up 100 per cent a year,' he said. 'You still need a diversified portfolio.'