With the global emerging markets landscape changing rapidly, disparities among investment returns are growing quickly as well – making the choice of the right market exposure more critical than ever, according to a new commentary released today by the BlackRock Investment Institute (BII).
Andrew Swan, Head of Asian Fundamental Equities:
“In regards to China equities, in the short-term we are concerned by the surge in credit growth, underreported bad loans and a rapidly growing shadow banking system, combined with a weak economic recovery to date. Rising wages are hitting corporate profits, and food inflation could cause monetary tightening measures as we go into the second half of 2013.
“As a result, stock selection will be vitally important as China becomes more of an alpha market than a beta one. For example a key area of interest for us includes the healthcare sector, which benefits from both a good top-down and bottom-up story. China’s aging population is increasing the demand for healthcare, while at the same time we are seeing a growing number of high quality companies in the sector.
“ASEAN markets have rallied and are at high valuations with lots of portfolio inflows and a reliance on dollar funding. Political risk is always lurking. But on the plus side, the region is a prime beneficiary of businesses fleeing China’s wage inflation, bouts of anti-Japanese sentiment and deteriorating environment. And local incomes, consumption and investment are rising rapidly.”
Joel Kim, Head of Asia-Pacific Fixed Income:
“Emerging debt is still attractive in a richly valued fixed income world. Emerging market bonds offer relatively high yields in the zero rate world – but it will be tough to replicate the double-digit returns of the past. However deeper markets mean more choices – and more opportunities to out- or underperform.
“Explosive growth in emerging market pension assets underpins structural demand for emerging debt. In addition, emerging debt markets have also significantly jumped in size, credit quality and diversity: in 2012, the Asian credit market (ex-Japan) experienced record issuance in excess of $100 billion and the Asian local bond market (ex-Japan) reached over $6.5 trillion at the end of the year. This means more opportunities to separate the wheat from the chaff.
“Emerging debt still beats negative real rates on many ‘safe’ developed market government bonds, however a lack of liquidity remains a risk, and we think this is unlikely to improve. Investable emerging market debt is almost three times larger than US high yield, but trading volumes lag.
“As mentioned however, credit quality has greatly improved, for instance, the Philippines has already obtained its first ever investment grade rating from Fitch and it is expected that Moody’s and S&P will follow suit. The expected upgrades will increase the size investment grade universe in the investible Asian credit market and strong fiscal positions and changed investor perceptions of risk underpin this trend.
“We believe local emerging debt is interesting and may offer investors the opportunity to cash in on currency appreciation (or lose on depreciation). Three-fifths of returns on local debt was due to currency movements in the period 2004–2012. Asian bonds demonstrated significantly lower volatility than equities (approximately only ¼ of the volatility in equities on average) based on data from past five years. The low volatility also allows Asian bonds to have much stronger risk-adjusted returns than equities based on historical data.”
Ewen Cameron Watt, Chief Investment Strategist, BII:
“Choosing the right exposure (and there are many) is becoming even more important as economies and financial markets mature at a very different pace. Disparities among countries, cities and companies are growing fast – and so are disparities among returns. Not only are the different types of emerging market exposures important to note, but also the effects of a deepening financial market; urbanization; the impact of the world’s second largest economy, China, shifting to a consumption-driven economy; and not to forget the increasing global appetite for food (and fresh water).”
Jeff Shen, Head of BlackRock Emerging Markets:
“The emerging world’s share of the global pie is growing – but it has a long way to go, especially in financial assets. The total free-float market capitalisation of all emerging stocks is just one-eighth of the global total. The growth in assets, however, is faster in emerging markets. Emerging markets are rapidly catching up to the developed world. High economic growth, however, is no guarantee for high financial returns – especially not in equities.
“China’s rebalancing of its economy is a risk, as the country has been the driver of burgeoning intra-emerging markets trade. Credit expansion at multiples of nominal economic growth is a warning sign. By this measure Turkey, Indonesia and China appear troubled. Our rule of thumb: Acceleration of credit growth + high foreign ownership of assets equal a red flag.
“The waning of US quantitative easing and/or a stronger US dollar could also spell trouble for emerging markets relying on external funding – especially for those countries that have seen recent credit booms. However on the flip side, dollar strength is not all bad news. If it originates from genuine growth in the US economy, it can be a tailwind for emerging market exporters.”
