Emerging markets: Thoughts on getting the timing right

If you believe in investing against the herd, ploughing some cash into the emerging markets should be a tantalising option for you right now. After all, the world’s investors have panicked about South Africa, Turkey and other so-called fragile countries and, in so doing, have stampeded for the exit.

Mike Browne of Seed Investments looks through the recent jitters to analyse what is really happening with emerging markets. His chart shows that emerging markets have been ticking down steadily for the past four years. If patterns are to be repeated, emerging markets are likely to start heading up again soon.  Earlier this month, Biznews.com published analysis showing that some US investors believe valuations in emerging markets are starting to look attractive. 

Mike suggests investing in actively managed funds with an emerging market focus. If, on the other hand, you prefer to manage your own money, consider investing directly in an emerging markets Exchange Traded Fund (ETF) on an international exchange (for more on how to do that from South Africa, read  Buying international shares from  your laptop in SA: tips to getting started).- JC

Emerging markets: Thoughts on getting the timing right

By Mike Browne

As multi managers we are tasked with determining which asset classes are showing the most value and then finding those managers that are best placed to capitalise on the opportunities presented – thereby generating satisfactory risk adjusted returns for our clients.

Mike Browne of Seed Investments explains how to understand numbers connected to bond investments.
Mike Browne of Seed Investments produces a chart that suggests the worst is over for emerging markets.

Asset class, in this context, is an extremely wide term and can be defined as any asset class in any region (or grouping thereof). A few examples include, South African banking companies, global equity, European property, emerging market debt, precious metals, small cap equity, Asian technology companies, etc. As can be seen, asset classes can either be very broadly (global equity) or narrowly (South African banking) defined. We typically allocate into broader asset classes, allowing the underlying manager to find the best opportunities, but there will be times when we’ll make a special allocation to a more tightly defined asset class where we see a special opportunity.

Making these kinds of decisions requires a fair amount of research into the relative performance and valuations of the various asset classes, how the returns are correlated with other asset classes in our Funds, prospects for the asset class, whether there are any managers that have shown a proven ability in the specific asset class, etc.

Over the past few years, for instance, our global equity allocation has been allocated purely to high quality, globally branded companies that have delivered excellent – market beating – returns. While the returns have been great, we understand that all good things come to an end, and valuations of these companies are not as attractive as they were in 2011. We are currently in the process of reducing our allocation to high quality companies in favour of more a more cyclical allocation. Also on the radar is whether to move a portion into Emerging Market (EM) equities.

The chart below shows the relative performance of Developed Market (DM) and EM equities since the inception of the EM index (both in US$). The line going up represents EM outperformance and the line heading down represents DM outperformance.

 

EmergingMarkets1

 

 

Emerging Market equities have outperformed Developed Markets by 3.6% per annum over this period, but have been underperforming since October 2010. The underperformance has been a combination of high starting relative valuations (in local currency) being de-rated to more normal levels and the vast majority of EM currencies weakening against the US$ over the past 3 years or so. There naturally is risk that Emerging Markets can continue to underperform over the next couple years, but the entry point is getting more attractive both on a currency and a valuation viewpoint.

We are busy with the process of identifying a suitable EM manager and determining when the correct entry point will be, so that when the time is right we are ready to invest.

 

Mike Browne started his investment career with Exsequor Investments (Seed’s forerunner) in 2005 after graduating from the University of Cape Town with a BBusSc (Finance) degree. While working at Seed, Mike successfully passed all three CFA exams, and was awarded his CFA Charter in 2009. Mike currently manages Seed’s unit trusts and spends a large portion of his time conducting investment research and meeting fund managers. Mike is on the Investment Committee and is a Portfolio Manager at Seed Investments.

For more by Mike Browne, read:

Investing in bonds: What the risks are and how to read the yield curve

South Africa’s Rand compared to other currencies: a lesson on purchasing power parity

Wealth creation: The investment case for Africa

Warning: After another cracking year, equity returns will probably disappoint in 2014 – investment fund