Global Investing

Emerging markets; turning a corner

Emerging markets have been attracting healthy investment flows into their stock and bond markets for much of this year and now data compiled by consultancy CrossBorder Capital shows the sector may be on the cusp of decisively turning the corner.

CrossBorder and its managing director Michael Howell say their Global Liquidity Index (GLI) — a measure of money flows through world markets — showed the sharpest improvement in almost three years in June across emerging markets. That was down to substantially looser policy by central banks in India, China and others that Howell says has moved these economies “into a rebound phase”.

This is important because the GLI, which has been around since the 1980s, has been a fairly accurate leading indicator, leading asset prices by 6-9 months and future economic activity by 12-15 months, Howell says:

Weak liquidity has been the key reason why EM shares have underperformed for so long. More liquidity may now allow EM markets to catch up.

The picture isn’t perfect. CrossBorder’s Global Liquidity index measures currently at 47.8, where a number above 50 denotes expansion. But the number in emerging markets was a still-low 24.1 last month, though it was 20.4 in May and is up 8 points this year.

Ecuador: a successful emerging market?

A colleague of mine, Marius Zaharia (@MZaharia) interviewed Moritz Kraemer, Standard and Poor’s head of sovereign ratings for Europe, Middle East and Africa. (you can read the interview here) Kraemer offered this piece of advice to the African governments who are busily tapping bond markets these days:

    What I want to tell all those governments in africa is that you are not a successful market participant when you’ve issued your first eurobond. You are a successful participant when you’ve paid it back for the first time.   

A sound piece of advice. But where does that leave Ecuador which has a frequent history of default spanning three centuries? One might argue in fact Ecuador’s market strategy has been highly successful — not only has it avoided repaying creditors, it also seems adept at persuading them to part with more cash at regular intervals.

Braving emerging stocks again

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.

No more “emerging markets” please

The crisis currently roiling the developing world has revived a debate in some circles about the very validity of the “emerging markets” concept. Used since the early 1980s as a convenient moniker grouping countries that were thought to be less developed — financially or infrastructure-wise or due to the size or liquidity of their financial markets — the widely varying performances of different countries during the turmoil has served to underscore the differences rather than similarities between them.  An analyst who traveled recently between several Latin American countries summed it up by writing that he had passed through three international airports during his trip but had not had a stamp in his passport that said “emerging market”.

Like this analyst, many reckon the day has come when fund managers, index providers and investors must stop and consider  if it makes sense to bucket wildly disparate countries together.  After all what does Venezuela, with its anti-market policies and 50 percent annual inflation, have in common with Chile, a free market economy with a high degree of transparency  and investor-friendliness?

Deutsche Bank analyst John-Paul Smith is one of many questioning current index-based investing models which he says essentially provide a free ride to the Russias and Venezuelas of this world, who may be undeserving of investor dollars.  Simply by virtue of inclusion in the emerging index, a country becomes a “default beneficiary” of passive investment flows — from funds that hug or track the benchmark — Smith says. In a note he calls for the abandonment of current index criteria such as market access, liquidity or per capita income in favour of a “substantive governance-based view of risk”
In other words:

Market cap of EM debt indices still rising

It wasn’t a good year for emerging market bonds, with all three main debt benchmarks posting negative returns for the first time since 2008. But the benchmark indices run by JPMorgan nevertheless saw a modest increase in market capitalisation, and assets of the funds that benchmark to these indices also rose.

JPMorgan says its index family — comprising EMBI Global dollar bond indices, the CEMBI group listing corporate debt and the GBI-EM index of local currency emerging bonds — ended 2013 with a combined market cap of $2.8 trillion, a 2 percent increase from end-2012. Take a look at the following graphic which shows the rise in the market cap since 2001:

Last year’s rise was clearly much slower than during previous years.  It was driven mainly by the boom in corporate bonds, which witnessed record $350 billion-plus issuance last year, taking the market cap of the CEMBI to $716 billion compared to $620 billion at the end of 2012, JPM said.

The annus horribilis for emerging markets

Last year was one that most emerging market investors would probably like to forget.  MSCI’s main equity index fell 5 percent, bond returns were 6-8 percent in the red and some currencies lost up to 20 percent against the dollar.  Here are some flow numbers  from EPFR Global, the Boston-based agency that released some provisional  annual data to its clients late last week.

While funds dedicated to developed markets — equities and bonds –  received inflows amounting to over 7 percent of their assets under management (AUM), funds investing in emerging stocks lost more than 6 percent of their AUM.

In absolute terms, that amounted to a loss of $15.4 billion for emerging equity funds , banks said citing the EPFR data.

Steroids, punch bowls and the music still playing: stocks dance into 2014

Four years into the stock market party fueled by a punch bowl overflowing with trillions of dollars of central bank liquidity, you’d think a hangover might be looming.

But almost all of the fund managers attending the London leg of the Reuters Global Investment Summit this week – with some $4 trillion of assets under management – say the party will continue into 2014.

Pascal Blanque, chief investment officer at Amundi Asset Management with over $1 trillion of assets under management, reckons markets are in a “sweet spot … largely on steroids with the backing of the central banks.”

Red year for emerging bonds

What a dire year for emerging debt. According to JPMorgan, which runs the most widely run emerging bond indices, 2013 is likely to be the first year since 2008 that all three main emerging bond benchmarks end the year in the red.

So far this year, the bank’s EMBIG index of sovereign dollar bonds is down around 7 percent while local debt has fared even worse, with losses of around 8.5 percent, heading for only the third year of negative return since inception. JPMorgan’s CEMBI index of emerging market corporate bonds is down 2 percent for the year.

 

While incoming Fed boss Janet Yellen has assured markets that she doesn’t intend to turn off the liquidity taps any time soon, JPMorgan still expects U.S. Treasury yields to end the year at 2.85 percent (from 2.7 percent now). That would result in total returns for the EMBIG at minus 7 percent, the CEMBI  at minus 2 percent and GBI-EM at minus 7-9 percent, JPMorgan analysts calculate.

Bond market liberalisation — good or bad for India?

Many investors have greeted with enthusiasm India’s plans to get its debt included in international indices such as those run by JPMorgan and Barclays. JPM’s local debt indices, known as the GBI-EM,  were tracked by almost $200 billion at the end of 2012.  So even very small weightings in such indices will give India a welcome slice of investment from funds tracking them.

At present India has a $30 billion cap on the volume of rupee bonds that foreign institutional investors can buy, a tiny proportion of the market. Barclays analysts calculate that Indian rupee bonds could comprise up to a tenth of various market capitalisation-based local-currency bond indices. That implies potential flows of $20 billion in the first six months after inclusion, they say — equivalent to India’s latest quarterly current account deficit. After that, a $10 billion annual inflow is realistic, according to Barclays. Another bank, Standard Chartered, estimates $20-$40 billion could flow in as a result of index inclusion.

All that is clearly good news, above all for the country’s chronic balance of payments deficit. The investments could ease the high borrowing costs that have put a brake on growth, and kick-start the local corporate bond market, provided more safeguards are put in. Indian banks that have traditionally held a huge amount of government bonds, would at least in theory be pushed into lending more to the real economy.

Emerging equities: out of the doghouse

Emerging stocks, in the doghouse for months and months, haven’t done too badly of late. The main EM index,  has rallied more than 11 percent since its end-August troughs, outgunning the S&P 500′s 3 percent rise in this period. Bank of America/Merrill Lynch strategist Michael Hartnett reminds us of the extreme underweight positioning in emerging stocks last month, as revealed by his bank’s monthly investor survey.  Anyone putting on a long EM-short UK equities trade back then would have been in the money with returns of 540 basis points, he says.

Undoubtedly, the postponement of the Fed taper is the main reason for the rally.  Another big inducement is that valuations look very cheap (forward P/E is around 9.9 versus a 10-year average of 10.8) .

According to Mouhammed Choukeir, CIO , Kleinwort Benson:

Looking at valuations we think emerging markets are in an attractively valued zone, hence we think it’s a good investment. EMs are in negative momentum trend but have good valuations. We’re sitting on the positions we’ve built but if it hits a positive (momentum) trend we will add on it…. You wait for value and value will translate into returns over time.