Cracks starting to appear in some economies, says Australian CEO
Professor Amin Rajan
Outstanding returns from emerging markets may be a thing of the past, as investors become more discerning and economies develop at very different speeds.
This was one of the key findings from “Not all Emerging Markets are Created Equal”, the 2014 annual CREATE-Research report (the Report), commissioned by Principal Global Investors and its parent company, Principal Financial Group® and released today. The Report distills the views from 704 pension plans, sovereign wealth funds, pension consultants, and asset managers from around the world and reveals in-depth insights from structured interviews with 110 organisations.
Given recent volatility and sell-offs in emerging markets, this year’s Report addresses whether emerging and developed markets will continue to converge, and where global investors are likely to see value in the coming years. These questions and others are framed against the backdrop of the likely effect on global markets of four unknowns: the tapering of quantitative easing, slow deleveraging in the Eurozone, the “three-arrow” initiative in Japan and the credit explosion in China.
The Report reveals that despite recent poor performance, investors have not lost faith in emerging markets. However, they are becoming more discerning as as emerging markets are increasingly considered a tactical investment opportunity. In addition, emerging markets are no longer seen as a homogenous group and only those countries embracing a reform agenda are likely to continue to converge with the West, both structurally and financially.
Professor Amin Rajan, CEO of CREATE-Research and the author of the Report, said that by way of example, 35% of respondents said that China would deliver real growth over the next three years, whereas only 15% thought that Brazil would. In the same way, nearly half of respondents believe China will push forward with economic reform, but only 6% think that Russia will.
“Marked volatility and concern about the political will to aggressively pursue a reform agenda has certainly made investors more wary about their previous ‘buy-and-hold’ strategy,” Professor Rajan said. “And as a result, more investors view emerging markets as an tactical play.”
Professor Rajan went on to say that neither emerging nor developed markets would return to full health until some root causes of global weakness are addressed.
“Reducing debt, strengthening public finances, promoting growth and boosting competitiveness are challenges which Governments across the globe must all find ways of meeting,” he said.
Commenting on the findings of this year’s survey in the Australian context, Grant Forster, CEO of Principal Global Investors (Australia) noted that some of the previous strong returns from emerging markets were clearly more about quantitative easing than they were the inherent strength of the economies in question.
“Now that tapering has begun, the cracks are starting to appear in some economies,” he said.
“Countries which continue to backslide on reforms and are struggling under the weight of massive trade and budget deficits are unlikely to perform looking forward.”
Mr Forster said that the revelations from the Report raised important questions for Australian investors, as they come to terms with the fact that the economies within emerging market groups, often described by catchy acronyms, like BRICS, will no longer move in lockstep.
“These acronyms were more marketing driven than investment driven and highlight the inherent dangers of oversimplifying opportunities in complex and less developed economies and markets. These markets contain diverse economies and societies – they do not move in lockstep over the medium-term,” he explained.
Mr Forster went on to say that the Report also raised the interesting questions about the future for frontier markets. Investors have typically been cautious about these markets due to their higher levels of risk.
“It’s true that despite the positive outlook for population and growth in some frontier markets, the political and governance risks remain real, and for the time being these markets are still very illiquid,” Mr Forster explained. “However, it is likely that we will start to see the kinds of changes we saw in emerging markets in frontier markets in the future.”
In conclusion, Mr Forster said that while there may be marked differences in the pace, developing markets will, by their nature, continue to progress.
“A strategic allocation to emerging markets will definitely remain important to investors with a long-term perspective, and even at the moment, emerging market equities look attractive on a relative valuation. Given the diversity and very different stages of development of emerging economies and markets it is also prudent to consider opportunistically shorting from both a hedging or alpha perspective.
“Drawing on the skills of specialist managers to help identify specific opportunities will be the trick,” he said.
Key findings of the report include:
- Emerging and developed economies’ market structures will continue to converge over this decade.
– 56% of the respondents expect further convergence between East and West in terms of market structure.
– Only 32% of respondents expect further convergence in investment behaviours, with nearly 60% expecting no change in this area. - Emerging markets will no longer be considered one homogenous group.
– Emerging market countries are progressing at very different speeds.
– Country-specific risks gain importance over macro risks, giving way to the rising significance of stock-picking.
– Investors are questioning the emerging market story, with those who believe in emerging markets dropping from 38% to 20% since 2012.
– China is leading the way in the East with more than 50% of investors positive about the country’s economic outlook in the near-term. - The US is regarded by investors as the key driver of the global economy over the next three years.
– 47% of investors believe the US recovery will deliver the best returns.
– Nearly 65% of investors believe the US government will make significant progress in rebooting its economy over the next three years.
– 30% of investors think the outlook for Europe remains decidedly cloudy, with isolated pockets of revival expected only in Scandinavia and the UK.