To uproot or to plant? Emerging markets beckon

PUBLISHED : Sunday, 13 March, 2011, 12:00am
UPDATED : Sunday, 13 March, 2011, 12:00am

Is it time to pull money from emerging markets or to pile back in? From the recent torrent of money fleeing the emerging markets, the first option would seem like a no-brainer, yet there are signs that the stampede might be reversing direction.

Bloomberg reports that emerging-market stock mutual funds had their first inflows in seven weeks in the week to Wednesday as investments in developed-market funds slowed, according to Citigroup. An inflow of US$17 million during the week was the first since January 19, according to a report by Markus Rosgen, a Hong Kong-based Citigroup strategist, which cited data compiled by research firm EPFR Global.

Prior to this reversal, emerging-market funds recorded six straight weeks of outflows as violence in Libya disrupted oil supplies and fuelled concern that inflation would hurt developing economies.

However, crude on Friday was headed for its first weekly decline in four, sliding below US$114 after the massive earthquake in Japan.

The benchmark MSCI Emerging Markets Index is down by about 3.7 per cent since the start of this year. Many leading emerging-market funds, as the accompanying Morningstar chart shows, have also been in the red this year.

Hong Kong-based Ivan Leung, chief investment strategist at JP Morgan Private Bank in Asia, sees more volatility in the near term in emerging markets, but advises investors to ride out the turbulence. 'The structural long-term story for emerging markets is intact,' Leung says.

Deutsche Bank has also been telling investors to put money back into emerging markets with strong exports as they may benefit from a pick-up in US economic growth.

Leung believes there are opportunities in emerging-market equities as valuations are becoming attractive following the recent correction. He suggests new investors look for entry points to buy good growth stories at reasonable prices.

Fund mangers say money has been leaving emerging-market equity funds in favour of developed markets - an outflow that began in January - because of concerns about inflation. Rapid price rises are widely seen to be slowing the larger emerging economies such as Brazil and China.

Major global emerging-market funds focus on larger developing countries, leaving a relatively smaller proportion of their holdings in the smaller and less liquid markets such as Vietnam and Indonesia.

Moody's points out that high food prices are already a problem in most Asian countries. This, along with rising inflation linked to higher oil prices, is expected to erode consumers' purchasing power and dent the performance of emerging-market companies.

China remains heavily reliant on imported crude, and any slowdown in the country would dampen the wider Asia-Pacific market.

Inflation stands at 4.9 per cent in China. India is leading the pack with 8.23 per cent while South Korea's is 4.1 per cent, Indonesia 7 per cent, and Singapore 5.5 per cent.

Beijing has repeatedly increased interest rates of late to combat inflation, which in turn has held down mainland stock prices. Mainland equities are down roughly 5 per cent so far this year. But Kenny Wong, a manager with Saxo Capital Markets, said interest rate increases would have little effect in checking inflation.

Robeco, a boutique US fund management firm, holds a house view that a spike in oil prices would slow down the growth of countries that import a lot of oil. This includes many emerging economies, namely Turkey, South Korea and India (but not China).

However, the firm predicts that higher energy prices should benefit oil-exporting countries such as Russia and Brazil. Russia's stock market has appreciated by more than 18 per cent in the past three months, in step with rising oil prices.

Other economies that might benefit from the higher energy prices include the Middle East. Their markets are expected to be volatile in the short term for obvious reasons.

According to Baring Asset Management, Mena (Middle East North Africa) economies should benefit from the political changes and have a good potential for growth in the next 12 to 18 months.

Barings, which has a US$21 million fund that invests in Mena markets, says there are many companies with attractive equity valuations in the UAE, Qatar, Turkey and Egypt.

'With the Egyptian stock market closed, some of the most liquid stocks in the wider region have been sold off by investors who want to reduce exposure, and we can expect some short-term volatility,' said David Sanders, the Dubai-based chief investment officer at Invest AD Asset Management, which manages funds that invests in the Arabian Gulf, Gulf Co-operation Council states and Africa.

ING Investment Management's global emerging equity market strategist Maarten-Jan Bakkum said regime changes in the Middle East could lead to more complicated geopolitics, meaning higher risk premiums in the global equity market.

The strategist is cautious on markets such as India and Indonesia, where, Bakkum said, inflation had worsened, leading to a sharp underperformance relative to other emerging markets.

Although there were some signs that food inflation in China and India was being contained, the escalation and spreading of unrest in the Middle East should keep oil prices high in the near term, Bakkum said.

But most fund managers believe that, despite the risks of inflation and higher oil prices, the macroeconomic outlook remains favourable for emerging markets compared with developed markets, based on the higher growth and stronger external and fiscal positions of the former.

According to IHS Global Insight, a research firm, China's economy is expected to expand three times faster than America's this year.

Emerging markets' growth is likely to remain high, says Robeco, which expects emerging countries to grow an average of more than 5 per cent this year.

Robeco expects earnings growth for emerging and developed markets to be similar. It says it has recently made changes in its emerging-market fund portfolio to cut exposure to India and Brazil and increase investment in Taiwan.