Braving emerging stocks again

March 26, 2014

It’s a brave investor who will venture into emerging markets these days, let alone start a new fund. Data from Thomson Reuters company Lipper shows declining appetite for new emerging market funds – while almost 200 emerging debt and equity funds were launched in Europe back in 2011, the tally so far  this year is just 10.

But Shaw Wagener, a portfolio manager at U.S. investor American Funds has gone against the trend, launching an emerging growth and income fund earlier this month.

It’s a great time to launch a fund if you have a long-term focus in mind. Emerging markets trailed DM in terms of performance for a while, peaking at end of 2010 so we are 3-plus years into a down market and period of significant underperformance.

He may be onto something. Some analysts have tentatively started advising clients to start dipping their toes back into water, given how cheap emerging market valuations are. Societe Generale for instance which has been negative on emerging equities for 3 years, said in a note that the sector had gone from being “priced for perfection to deep value”.

Emerging equities trade around 10 times forward earnings, compared to 14 for their developed counterparts and down from 13 times back in 2010.  Check out this graphic by @ReutersFlasseur:

Meanwhile another bank, Barclays, notes emerging economies’ first-off-the-blocks recovery after the 2008 crisis,  meaning they ran into capacity constraints a couple of years before their advanced market peers. A shift in capital flows away from the developing world was therefore natural, they say.

Wagener, who has been investing in emerging markets since the 1980s, acknowledges the sector has been hindered by poor earnings growth, caused by poor management of state-owned companies but also rising labour and commodity costs, but he adds:

I think we are reaching a point where those things could inflect. A lot of companies have cut back on capex, people are starting to manage more for profit and we may see earnings growth bottom out.

Thomson Reuters Starmine data shows some limited signs of an turnaround in countries such as South Africa and Indonesia where currencies have depreciated hugely, even though 55 percent of companies have missed 2013 earnings forecasts.

Moreover,  as the name of the new fund (Developing World Growth and Income Fund) suggests, Wagener is taking aim at dividend payers, of which there are a growing number in emerging markets. That may be down to governments demanding more payouts from state-run firms (as in Russia where a 25 percent dividend is mandatory) or just managers recognising the need to keep shareholders sweet. In developed countries dividends comprise around 40 percent of long-term returns, he says while in emerging markets dividends are typically lower.

The current dividend yield in emerging markets is less than 3 percent but analysts expect this to rise to 3.5 percent next year, with countries such as Russia, Poland and the Czech Republic seen paying more than 5 percent, data from Morgan Stanley shows.

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