Emerging once more

Emerging markets equity investors took a beating in 2011, as rising inflation in these economies and a quest for liquidity in the developed world conspired against them. But the tide has turned, and now might be the time to pile back in.

Inflation, which had been rising in many emerging markets last year, is now declining. China’s official inflation rate fell from 6.5% in mid-2011 to about 4% in December. One of the more obvious benefits of this is that monetary policy can be loosened, sending capital into risk assets.

But there’s more to the story than easy money.

“What will be even more positive for emerging markets will be more appetite for risk,” says Stephen Burrows, senior investment manager on the emerging markets team of Pictet Asset Management, sub-advisor of the Renaissance Emerging Markets Fund. “Last year we had a very high level of risk aversion globally, and that means the appetite for riskier assets, like emerging equities, was much reduced.”

In 2011, emerging market equities saw net outflows of $48 billion, which dragged down the prices stocks. This year has already seen a substantial reversal, however, with $11 billion in inflows.

“Add to that, we started this year with a much lower valuation for emerging equities than we started 2011,” he says. “At the beginning of this year, emerging markets were about 9.5 times forward price-earnings ratio, which is very cheap by historical standards.”

Not only is that more than one full standard deviation below the historical average, but it also represents a 15% discount to developed markets.

“When you start to these kinds of value opportunities in EM, that tends to provide some very good returns for investors over the 12 month year.”

While emerging market equities are much more widely researched than they were in the past, he admits they are still less transparent than companies in the developed world. Across the emerging markets universe you’ll have as many different accounting standards as currencies, and management information may be rather opaque.

“Comparing a steel company in Brazil to a one in South Korea can be quite difficult, so we use an asset-based approach to comparing companies across emerging markets,” says Burrows. “Because they are volatile, you can often find companies trading below their asset value. For a long-term investor, that’s always a great time to pick companies up.”

He says he’s seeing companies trading at half the value of the cost of replacing their assets, which he calls a “tremendously positive” signal in emerging markets.

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.