Emerging markets are dishing out healthy returns to investors—and a big slice of humble pie to detractors.
After falling 21% last year, the MSCI Emerging Markets index rebounded strongly this year. The index was up 11% in January, outpacing developed markets by 7.6%. The Dow Jones Industrial Average rose only 3.4% during the same period. At the macro level, emerging economies continue to be the fastest-growing, says ChukWong, vice-president and portfolio manager, Dynamic Funds; co-manager, Dynamic Emerging Markets Class.
“Industrialization and urbanization continue to take place [in these economies],” he says. “They have favourable demographics compared to the developed world.” Inflation, the primary concern in the first half of last year, is peaking in some of these markets. In China, inflation topped out last July, leading to monetary policy easing; that’s currently unthinkable for the industrialized word.
“We are at this inflection point when monetary policies [in emerging markets] are switching from tightening to neutral to easing in the future,” said Wong. “That is constructive for equities.”
In another sign of easing, key central banks in emerging markets have lowered their cash-reserve ratio. The People’s Bank of China cut the reserve ratio for its banks by 50 basis points in December. Paul Mesburis, senior portfolio manager at Excel Funds, points out that at 20.5%, there’s ample room for further easing.
The Reserve Bank of India, that country’s central bank, also reduced its cash-reserve ratio by 50 basis points to 4.75% and signaled future rate reductions.
But history provides the strongest arguments for remaining positive about the future of emerging markets equities. “Historically, equities are known to rally after central banks ease monetary policy,” said Mesburis.
“We expect further easing across emerging markets [as they] grow at about 5.1% in 2012 and 6% in 2013, compared to industrialized countries, which are expected to grow 0.9% and 1.2%, respectively.”
Led by China and India, emerging markets contributed to about 70% of global GDP growth in 2011. That’s expected to increase to 76% in 2012, Mesburis says.
This trend is further supported by growing signs of a U.S. recovery and expectations of a workable solution to the European sovereign-debt crisis, which contributed to emerging-market equities’ underperformance last year. This has helped lower the risk perception of global investors.
BRICs still interesting
BRICs have been the most fashionable markets, says Gustavo Galindo, portfolio manager, emerging markets at Russell Investments. “Among other things, it’s [a group of] countries from four regions and it gives [investors] a sense of diversification.”
But as attractive as the BRIC concept is, advisors should look beyond. Galindo says considering “quasi-developed economies” like Mexico or South Africa is a good idea. Even a smaller country like Indonesia was “a great performer in 2011 because of the macroeconomic development. And because it started from such a low base, the growth was easy to generate.”
Wong, who gives Indonesia and Thailand top billing in the Association of Southeast Asian Nations region, agrees.