In defence of co-investing with the state
It’s hard to avoid state-run companies if you are investing in emerging markets — after all they make up a third of the main EM equity index, run by MSCI. But should one be avoiding shares in these firms?
Absolutely yes, says John-Paul Smith at Deutsche Bank. Smith sees state influence as the biggest factor dragging down emerging equity performance in the longer term. They will underperform, he says, not just because governments run companies such as Gazprom or the State Bank of India in their own interests (rather than to benefit shareholders) but also because of their habit of interfering in the broader economy. Shares in state-owned companies performed well during the crisis, Smith acknowledges, but attributes emerging markets’ underperformance since mid-2010 to fears over the state’s increasing influence in developing economies. (t
Jonathan Garner at Morgan Stanley has a diametrically opposing view, favouring what he calls “co-investing with the state”. Garner estimates a basket of 122 MSCI-listed companies that were over 30 percent state-owned outperformed the emerging markets index by 260 percent since 2001 and by 33 percent after the 2008 financial crisis on a weighted average basis. The outperformance persisted even when adjusted for sectors, he says (state-run companies tend to be predominantly in the commodity sector).
Past performance and state support aside, Garner sees two inducements to buy shares in state-run companies. Firstly, they tend to trade relatively cheaply to their private sector peers (almost certainly because of the risks that state involvement is perceived to bring). Morgan Stanley calculates these companies are a fifth cheaper than the broader index, both on a forward price/earnings basis and on a price/book basis.
Secondly, many of these companies now pay decent dividends. Garner’s sample group of companies exhibits a dividend yield of 3.2 percent versus 2.7 percent for the MSCI index. That’s up from 1 percent in 2007 and should rise to 4 percent in 12, Morgan Stanley predicts.
It also expects a 15 percent upside to the share price for state-run companies.
Discovering the pleasure of dividends in Russia
American financier J.D. Rockefeller said watching dividends rolling in was the only thing that gave him pleasure. But it is a pleasure which until now has largely bypassed shareholders in most big Russian companies. That might be about to change.
Russian firms, especially the big commodity producers, are generally seen as poor dividend payers. So dividend yields, the ratio of dividends to the share price, have been unattractive.
On a trailing 5-year period, the average dividend yield in Russia was 1.8 percent compared to 2.5 percent for emerging markets, notes Soren Beck-Petersen, investment director for emerging markets at HSBC Global Asset Management. That absence of positive cash flow from companies is one reason why Russia has always traded so cheap relative to other emerging markets, he says.
See the following graphics from my colleague Scott Barber (@scottybarber)
But as the graph above shows, the ratio has been improving. Beck-Petersen says it stands now at 2.1 percent for Russia versus 2.7 for emerging markets. Smaller oil companies Bashneft and Surgut pay double-digit dividend yields on their preferred shares. Steelmakers Evraz and Mechel gladdened shareholders last year with decent dividends.
Emerging Markets: the love story
It is Valentine’s day and emerging markets are certainly feeling the love. Bank of America/Merrill Lynch‘s monthly investor survey shows a ‘stunning’ rise in allocations to emerging markets in February. Forty-four percent of asset allocators are now overweight emerging market equities this month, up from 20 percent in January — the second biggest monthly jump in the past 12 years. Emerging markets are once again investors’ favourite asset class.
Looking ahead, 36 percent of respondents said they would like to overweight emerging markets more than any other region, with investors saying they would underweight all other regions, including the United States. Meanwhile investor faith in China has rebounded with only 2 percent of investors believing the Chinese economy will weaken over the next year, down from 23 percent in January. China also regained its crown of most favoured emerging market in February.
Last year, the main EM index plummeted more than 20 percent as emerging assets fell from favour. So what is the reason for this renewed passion in 2012?
Firstly December’s LTRO — a multi-billion euro liquidity arrow from the cupids at the ECB has revived investor appetite for riskier emerging assets, boosting the index to around six-month highs since the start of the January. A second significant factor behind the resurgence in risk sentiment is that the market is daring once again to hope for an improvement in global growth, says Gary Baker, BofAML Global Research head of European equities strategy.
The big beneficiaries of all this have been emerging markets. It’s not just about liquidity. Clearly the actions of the ECB have been vitally important… but what you’ve also seen is an improvement in global growth optimism. If optimism over growth is improving then there may well be a more fundamental underpinning to the movement.
So is investors’ new-found love for emerging assets a passing flight of fancy or a true sign of commitment?
The significant monthly improvement in market sentiment towards emerging markets and the 44 percent level of investors overweight emerging markets are both events which have historically coincided with short-term underperformance by emerging equities, Baker says.
Can Eastern Europe “sweat” it?
Interesting to see that Poland wants to squeeze out more income from its state-owned enterprise (SOE) sector in the face of slowing economic growth and financing pressures.
Warsaw wants to double next year’s dividends from stakes in firms ranging from copper mines to utility providers to banks.
Fellow euro zone aspirant Lithuania has also embarked on reforms aimed at increasing dividends sixfold from what UBS has dubbed “the forgotten side of the government balance sheet”. It wants to emulate countries such as Sweden and Singapore where such companies are managed at arm’s length from the state and run along strict corporate standards to consistently grow profits.
The impetus isn’t entirely ideological. Poland and Lithuania are desperately trying to balance their books and under European Commission rules, privatisation proceeds cannot be taken into account when calculating the budget deficit but SOE dividends can.
But “sweating” government assets to yield higher profits doesn’t always come easy for central and eastern Europe. After all, this is a region where state ownership has been synonymous with inefficiency and stagnation.
Even so, the track record of emerging European governments on privatisation is mixed.
The haste at which state resources were sold off following the collapse of the Soviet Union had disastrous repercussions for economies such as Russia and Croatia. Recent efforts at state divestment from Poland to the Czech Republic to Romania have run aground on unrealistic price expectations, corruption or regulatory obstruction.
from MacroScope:
Emerging Europe property revival
People packing their bags and flying out to St Petersburg, Warsaw, and Prague this summer may not just be seeking an exotic vacation spot.
International property investors are inching back to emerging Europe, lured by prospects of higher returns in markets such as Poland, whose economy has held up relatively well in a global downturn, and Russia, which is bolstered by rising crude oil prices.
After posting strong growth for over 5 years, commercial real estate investments in emerging Europe had been a washout after Lehman Brothers’ collapse in Sept ‘08, with first quarter sales hitting a record low.
As our Moscow-based property reporter Yuliya Komleva and I wrote , major property fund managers such as Germany’s DekaBank, UK’s Aberdeen, and Hines from the United States have again looking for big buys in the region, although Hungary, Ukraine and the Baltics remain largely no-go zones.
Aberdeen Property Investors’ managing director for Russia, Charles Voss, even compared Russian cities favourably against London, where the once-booming UK financial services industry has been weakened by the global financial crisis.
"They don't anticipate all those jobs to come back immediately so the demand for office space will be weak (in the UK). Even though they are starting to get to the bottom, the growth curve in terms of additional value can be less than what can be in found Russia," says Voss, who sits in Russia’s cultural and historical capital of St Petersburg.
With property prices diving and driving up yields in London however, investors are looking to squeeze higher returns in emerging Europe, says Jones Lang LaSalle (JLL) head of CEE Capital Markets & Investment Tomasz Trzoslo.
EBRD to puzzle over E.Europe crisis
Ministers and bankers meeting at the European Bank for Reconstruction and Development‘s annual gathering in London tomorrow and Saturday have a sorry mess to scrutinise.
By the bank’s own (revised) forecasts, its region of central and eastern Europe will contract by over 5 percent this year. Many countries in eastern Europe took too much advantage of western banks’ lending spree, and businesses and households are struggling to pay back foreign currency loans.
Falling commodity prices have hit countries like Russia and Kazakhstan, and a burst consumer credit bubble is risking double-digit contraction in the Baltic states and Ukraine.
The bank’s 61 country members together with the European Union and its development bank the European Investment Bank will be discussing how to cope with the crisis and manage any recovery.
They will be looking at whether to continue giving help to several EU member countries which were due to stop receiving EBRD funds next year. Some countries may also be asking for an increase in the EBRD’s capital from its current 20 billion euros, to cope with the crisis.
The EBRD operates in 30 countries, mainly in the former communist bloc, and most recently Turkey. Those countries may be wondering if the bank could have done more to help them through the crisis, and seek more help now.
The EBRD is probably doing all that it can, but with almost 30 countries in distress it sees the bottom of its financial resources.
Zeitgeist check
Some more bits and bobs to capture the current mood among investors.
– So far, 2009 is worse than 2008 for stock investors. MSCI‘s main world index is down around 17 percent in January and February. A year ago, it had lost around 8 percent.
– Eastern and central Europe are the new worries because of bank exposure to troubled economies. ”The travails in the east, like the vampires of folklore, are sucking the lifeblood from European markets and investor sentiment,” State Street suggests.
– Cross-border flows into the euro zone hit record lows in February, the same firm says.
– Denmark and Sweden join the gloomy gang. Year-on-year Swedish GDP lost 4.9 percent in Q4 2008 and Denmark’s was down 3.9 percent.
– We have just had the worst month ever for global corporate earnings revisions, according to Societe Generale number maestro Andrew Lapthorne. “Earnings estimates for 2009 saw a 14 percent cut last month, a rate of downgrades twice that seen during the worst moments of the early 1990s recession,” he says.
