INVESTORS’ biggest concerns focus on the developed world – the euro’s existential crisis and the possibility of a US ‘double dip’.
But investing in the emerging world has not been easy either of late: indeed, stock markets there have now slightly underperformed developed markets since mid-2009 – and the high-profile BRIC quartet (Brazil, Russia, India and China) more than most.
The underperformance is visible in common currency terms, as some emerging exchange rates have fallen sharply in recent months. From 2011 highs, Brazil’s real is down by a quarter, India’s rupee by a fifth, and the rouble by a sixth against the dollar.
It can be seen however even in local currency (or ‘currency-hedged’) terms. This is at odds with received wisdom, but should not really be a big surprise. Emerging economies’ weight in global capital markets (around a tenth) is likely to rise towards their share of global population (conservatively put at two-thirds): when information, capital and technology are internationally mobile you need a good reason to expect it not to. But this is a (very) long-term process, and tactically the story can ebb as well as flow. It has been pretty much in full spate since China’s accession to the WTO at end-2001.
Emerging markets are still relatively illiquid, small, and commodity-dependent, and so can be heavily influenced by shifts in risk appetite, institutional portfolios and resources cycles. Their economies have not decoupled from the developed world, nor are they likely to. And locally, there has been short-term disappointment at policy reform (India and Russia), inflation (India and Brazil) and corporate and political governance (India and Russia). Even China, one of our favourite tactical and strategic emerging stock market plays by virtue of its structural growth, diversification, monetary strength and very visible economic and financial reform, faces a short-term cyclical slowdown as well as some obvious long-term political challenges (we think that slowdown has largely run its course – the latest batch of data seem to point to this – but it is clearly still affecting market sentiment).
In seeking attractively-valued equity investments for the medium-term (two to three years, say) we have been focusing mostly in the last year or two on the developed world, where the room for positive surprises may be greatest because expectations are so low. We think that euro area politicians do increasingly ‘get it’ where the banking system is concerned, and see the memorandum of understanding on recapitalising the Spanish banks as a further tentative step forward. We still believe that US consumers are more resilient than feared, even as their confidence takes a knock. And as we note inside, by picking developed stocks carefully, investors can obtain the best of both worlds – inexpensive exposure to emerging world growth via liquid and transparent ‘local’ exchanges.
Direct exposure to emerging markets currently may be better taken through bonds than equities, particularly where inflation-indexed versions exist. Yields are higher, and have further to fall, than in developed markets. Exchange rate risk is however important – much more so than with equities – and careful selection (or an actively-managed fund) is advisable.
Andrew Miller is regional office head at Barclays Wealth in Newcastle