By Pieter Hundersmarck
19 February 2020
Global stocks outperform overall, but there are pockets of value for seasoned investors.
Early in my career I comanaged an emerging-markets fund that delivered market-beating returns from 2007 to 2014. After this good run a tough year ensued, which ate into our hard-won returns of the previous seven years. Friends teased me, asking how our “submerging markets” fund was doing.
The term wasn’t wrong. The year 2015 turned out to be an annus horribilis for emerging markets. There were other drawdowns, most recently in 2018, that could make your stomach turn.
But how have emerging markets treated investors over meaningful periods of time? The table compares the annualised returns of global markets (the MSCI all country world index), the JSE (the JSE all share index) and emerging markets (the MSCI emerging-markets index), over the past 10 and five years.
Performance is dependent on your starting point, but as of December 31 an amount of R100,000 invested in the global markets index 10 years ago would have grown to R464,898, versus R280,634 in the emerging-markets index. For the past 10 years, and nearly all time periods in between, investors in the emerging-markets index would have been better served in global indices.
Excluding China, which is the largest emerging market in the 24-market emerging-markets index published by MSCI, the returns look far more dire. A strong US dollar, subdued economic growth and turbulent political environments are all partly to blame.
Investing in emerging-market equities requires experience. The long-term prospects remain attractive, but timing your entry and exit is vital. Unfortunately, the uninspiring emerging-market returns have led many investors to avoid the asset class. We believe this is misguided.
The case for emerging markets is compelling. Of the world’s 7.7-billion people, almost 7-billion live outside the developed markets of the US, Europe and Japan. Between now and 2030 the UN expects them to account for almost all of the additional 800-million people, while 90% of the new entrants into the middle class will come from emerging Asia.
The fortunes of the emerging-market economies differ. Some, like India, are succeeding. India’s economy, as measured by wealth per adult, has expanded fourfold in the past 18 years. In China, the same metric has increased a staggering 11-fold. In both economies the level of poverty has fallen precipitously, and access to infrastructure has greatly improved.
To generate good returns in emerging markets requires investors to get comfortable with the uncomfortable.
Others, like Brazil and our own SA, have seen less success since 2000 and are mired in tepid growth scenarios for the foreseeable future (though Brazil is markedly improved from recent lows). Still others, like Argentina and Turkey, are handicapped by politics and high inflation, to the detriment of their growth prospects.
Investing directly in emerging markets requires specialisation. Most emerging-market stocks lack the deep institutional support that US and European equities enjoy, and hence need to be navigated more carefully. Volatility is greater in emerging markets. Exuberance in their prospects leads investors to bid emerging-market share prices up far beyond fundamentals and sell them with gusto at the first sign of trouble.
Finally, the macroeconomic outlook is often critical when assessing the currency risk of emerging-market stocks. A respectable share price return in local currency can look poor when translated to hard currency.
Accessing emerging markets needn’t always involve investing directly in emerging-market stocks. Many European- and US-listed companies operate large emerging-market businesses and trade at attractive prices in relation to their growth rates. Consumer staples companies Heineken and Mondelez and beauty and cosmetics companies L’Oréal and Estee Lauder are a few of the many examples.
To generate good returns in emerging markets requires investors to get comfortable with the uncomfortable. At Flagship we run global strategies that allow us to climb in and out of emerging markets when the valuations are appropriate. Our many years of experience in the asset class assists with this.
For example, despite the doom and gloom surrounding Turkey, opportunities to pick up bargains remain. Our Flagship Worldwide Flexible Fund has picked up a sizeable position in AvivaSA, the leading insurer in the market, at less than 10 times forward earnings. At this price AvivaSA offers investors a multiyear growth trajectory that will compensate for currency and political volatility.
South Africans know well that for all the attraction of global stocks, some emerging market stocks (including SA ones) can deliver outsize returns when they are bought and sold correctly. Investing in emerging market stocks as part of a globally diverse portfolio is one way we believe this can be achieved.
Pieter is a co-portfolio manager of Flagship Asset Management’s global funds.