IN CONVERSATION

Why emerging markets aren’t a tactical bet

Murray DaveyPension funds no longer view the emerging markets as a tactical play, instead considering the region a strategic allocation within their portfolios. Murray Davey, managing director and chief investment officer – global emerging markets at UK-based Rexiter tells Kristen Paech why.

As the global economy fell into recession, talk was rife about whether or not the emerging markets had “decoupled” from the West.

But as stock markets turned south, it became evident that no region was safe, and the emerging markets suffered, particularly in the last quarter of 2008, as liquidity-strapped institutions sold assets in the region in a bid to reduce risk.

Despite the initial sell-down, which resulted in a sharp underperformance of emerging markets relative to developed markets, the situation has since reversed.

Murray Davey, managing director and chief investment officer – global emerging markets at Rexiter, says US investors have more invested today in emerging equities as a proportion of their total equity funds than they did this time last year.

“Since [the sell-down] we’ve seen that emerging economies have been much more resilient than developed, and increasingly evidence that the problems which caused the recession and the falls in markets were much more concentrated in developed markets than they were in emerging,” he says.

‘The combination of those two factors pulled people back into emerging markets and we saw in the first and second quarters of the year relative outperformance of emerging markets to take them back to where they were in relative terms at the beginning of the crisis.”

Rexiter is owned by State Street Global Alliance, which is in turn owned by State Street Corporation and the 173 billion ($245 billion) Dutch pension fund, ABP.

A specialist in emerging markets and Asian investments, the company was built around the global emerging markets and Asian team at Kleinwort Benson Investment Management (KBIM), latterly Dresdner RCM Global Advisors. The team left KBIM in 1997 following the merger with Dresdner RCM and set up Rexiter.

While the emerging markets are still perceived to be risky by institutional investors, Davey says they are also concerned about the prospects for medium-term growth in developed markets, due to the “payment” for the government-led rescue.

“Debt levels in developed economies and the banking systems are all relatively weak and most of those problems are not apparent in emerging markets,” he says.

“So the other thing that institutional investors are looking at is that longer term perspective of higher growth in emerging market economies. They’re moving away from using emerging markets just as a risk tool and more to increasing a strategic allocation to what they see as the area of the world economy that is most likely to grow over the next decade or so.”

As pension funds become more convinced of the strategic need to have emerging markets exposure within their portfolio, Davey says they have begun to regard setbacks as a buying opportunity, rather than a reason to sell.

‘We saw in our clients as the markets fell an increase in their exposure; they actually bought more at that time,” he explains.

‘That’s a reflection of the long-term strategic thinking… in generality it’s true that the view of emerging markets has changed progressively over the last few years towards regarding it as a strategic investment rather than a tactical one.”

When it comes to the emerging markets, much of the discussion centres on China as the next super-power, which together with India has demonstrated the most resilience to the global economic crisis.

The Chinese local stock market is now the second biggest in the world, having overtaken Japan last month.

In a recent note, Christina Chung, senior portfolio manager at RCM, said China had the potential for sustainable recovery in 2010, with signs of recovery in domestic demand.

“We have seen recovery in consumption as indicated by the performance of various retail companies and consumer brands,” she wrote.

“Underlying domestic demand is strong in China. The level of household debt is low and the household savings rate is high, whilst income is slowly rising. Property and stock market gains have contributed to the recovery in consumption in China and the sharp recovery in the property sector is beyond even the expectations of Chinese developers themselves.”

While Rexiter shares the enthusiasm of a lot of emerging market investors about China, in the short-term it views China as a “crowded trade” and hence sees more opportunities in other markets.

“Places like Korea, which has been badly hit by the technology and global slowdown, and that’s been compounded by what’s been going on in the local market, so Korea we see as cheap and good value at the moment,” Davey says.

“Brazil, because of both its resilience as a domestic economy and its exposure to China, is another market we like.”

For the last 20 years, emerging economies have shown that they’re able to grow at between two and three times the rate of developed economies.

But for the first half of that period, growth in the economies was not mirrored by growth in the companies available to invest in.

That’s changed, especially on the back of the Asia crisis, and in the last 10 years, growth in the economies has been matched by the growth in the profits of the companies.

Davey believes this is one of the key drivers behind the growing exposure of pension funds to the emerging markets.

“So we’re seeing profit growth as well as economic growth and if that continues, which we think it will, then the individual risks of one individual stock get overtaken by that general trend,” he says.

“You still need a widespread diversified approach, you have to have a medium-term approach, but over [long] periods you have made more money in emerging and we think you’ll continue to do so.”

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