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Current Opportunities in Emerging Markets
Summary
2008 was clearly an exceptionally difficult year for financial
markets, and emerging market equities suffered more than most
in the rush to sell risk assets. However, the longer term prospects
for these markets appear attractive. The landscape of the world
economy has changed dramatically over recent years, and we
believe that it will be the emerging markets that will lead us
out of the current slowdown. Against this backdrop, the market
turbulence has produced some very interesting investment
opportunities, which we will explore in more detail in this article.
Steep equity market falls
In the past, emerging market (EM) equities were renowned for
displaying classic ‘boom and bust’ characteristics. However, up
until the summer of 2008, the asset class seemed to have broken
out of this pattern, and had embarked on
a long period of relative outperformance,
as investors had started to recognise its
superior growth prospects and improving
risk profile. This outperformance continued
even in the face of slowing global growth,
as despite downgrades to growth
expectations for emerging markets, it was still apparent that
they would deliver more robust growth than their developed
counterparts.
However, emerging market equities’ strong performance came
to an end in the summer of 2008 as the financial crisis worsened.
Unlike previous emerging market declines, this was largely
caused by global events in the developed world. Turmoil in the
financial markets sparked a universal flight to quality, in which
investors shunned all but the safest assets and sold others
indiscriminately. Emerging market equities underperformed
developed equities over 2008, and were the worst performing of
the risk asset classes during the main period of the crisis, wiping
out three years of gains.
So where does this leave us now?
Since the sharp falls in the final quarter of 2008, markets seem
to have started to stabilise, perhaps because the heavy selling of
assets during 2008 meant that most of the potential sellers have
already sold. EM equities have been trading in a defined range
for some months, and have outperformed their developed peers
since the start of 2009. The recovery has been led by Chinese
equities, but the Russian market has also stabilised after very
sharp falls.
Debt markets have been more resilient
Emerging market equities have been an established feature
in pension funds for some time and so are likely to be familiar
to most investors, but emerging market bonds may warrant a
short introduction. Emerging market debt has come a long way
since the crises of the 80s and 90s. Improved economic policies
have brought stability to this market. The benchmark JP Morgan
Emerging Market Bonds Index is now rated investment grade.
Better credit ratings have attracted more
investors, which in turn has boosted liquidity.
As a result, markets for emerging market
debt now comprise some $4-5 trillion of the
world’s estimated $23 trillion bond market
capitalisation (source: JP Morgan). Emerging
market debt offers a mix of sovereign,
municipal, corporate and structured debt, just as developed
markets do, in both hard and local currency, providing investors
with a range of opportunities from very high quality investment
grade to high yield assets.
Emerging market debt held up much better than equities in 2008,
meaning that they were one of the best-performing asset classes
during most of the market turmoil. They succumbed to the sell-
off in risk assets only in the fourth quarter, when spreads over
US treasury bonds widened to very wide levels. More recently,
the market has begun to show signs of stabilisation, and spreads
have started
to narrow.
The longer term outlook
However, although the short-term outlook may be opaque,
the long term investment case for emerging markets is a very
strong one. Emerging markets have young populations, growing
Current Opportunities in Emerging Markets Chris Gower, Head of European Consultant Relations, HSBC Global Asset Management
Strong domestic
demand is bucking
the global trend
consumer spending power and a burgeoning middle class. Strong
domestic demand is bucking the global trend. These countries
have over 80% of the world’s land, and abundant natural
resources.
According to the IMF, emerging markets are expected to
contribute nearly 90% of world growth in 2009, and over 60% in
2010. The main export markets of the US and the Eurozone are
of course much weaker than they were, but emerging markets’
dependence on exports to the developed world has stayed at a
steady 20% since 2000. Many emerging market governments
have also embarked on ‘self-help’ programs, by announcing
substantial fiscal stimulus packages.
In addition, with a few exceptions
(notably in Eastern Europe), emerging
markets have escaped the structural
debt problems plaguing the developed
world, and have healthy current account
and fiscal balances. Those countries
with high savings rates and modest debt
should weather the current storm fairly successfully. Emerging
market companies have also improved greatly in quality, and are
becoming increasingly ‘shareholder-friendly’. However, despite
all this, emerging markets make up only 11% of world equity by
market capitalisation, making them potentially attractive as a long
term investment.
Bearing these issues in mind, current valuations are offering
great opportunities for those investors that are willing to look
beyond the short term volatility. PE ratios are at 10 year lows,
with some areas trading at distressed levels. In particular, some
very attractive prospects are emerging in equity markets as a
result of the fiscal stimulus packages
being introduced by both developed and
emerging governments. If these are
successful in kickstarting economies,
the beneficiaries will be early stage
growth plays like industrials and
basic material stocks. Many of the
stimulus packages involve extensive
infrastructure investment, and any
companies directly related to infrastructure building will obviously
benefit from this. There are also indications that the sell-off in
energy stocks has gone too far, and some of these are now
offering value. In addition, in selected markets, consumer goods
companies that rely on local demand should continue to perform
well, as they are driven by the structural growth in the middle
class.
In the debt arena, credit spreads on emerging market sovereigns
have widened from a low of around 150 bps above the US
treasury yield in early 2007 to nearly 700 bps in early 2009.
Although headline risks remain, this widening has occurred
while the overall credit rating of emerging market sovereigns has
moved into the investment grade zone. At the time of writing
(March 2009) , the hard currency sovereign benchmark has a
yield of around 10% while the hard currency
corporate index has nearly an 18% yield. These
yields are projecting 1 year default rates of
nearly 7 to 8% in sovereigns and 20 to 25%
in corporates, while Moody’s estimates that
emerging market defaults will be less than 3%
in 2009. This suggests that there are many
attractive opportunities available.
Looking at a chart of market performance over the last year is a
disquieting experience, but for investors new to the asset class,
we are now at a very attractive entry point. Industry professionals
are even talking about a ‘once in a career’ opportunity. Although
volatility is likely to continue in the short term, it is well worth
looking beyond this at the longer term picture for emerging
markets.
Invest through a specialist
Even though emerging markets are progressing rapidly, there
are many more variables to consider than there are in developed
markets. Political, macro-economic and currency factors have
a major influence on the performance of
companies. Regulations and governance,
although improving in general, are not as
comprehensive as in developed countries,
which means that investment managers have
to understand a diverse range of countries,
regions and cultures if they are going to
be successful. When looking to invest in
these markets, it is therefore of paramount
importance to use a specialist investment manager with a strong
local network. Local knowledge is the key to unlocking the
potential of emerging markets.
Emerging markets
will contribute 90%
of world growth in
2009
For investors new to
the asset class, now
is a very attractive
entry point
First published in European Pensions, March 2009
For further information:
Head of Institutional: Richard Bottomley +44 (0) 20 7024 0756 [email protected]
Head of European Consultant Relations: Chris Gower +44 (0) 20 7024 0446 [email protected]
17121/0809/FP09-0348
Important information
The information contained in this document is confidential and is intended for use by the client named at the beginning, exclusively and may
not be reproduced or further distributed to any person or entity, whether in whole or in part, for any purpose.
The material contained in this document is for information only and does not constitute investment advice or a recommendation to any reader
of this material to buy or sell investments. It is intended for investment professionals only and not for distribution to
Retail Clients.
The views expressed are those of HSBC Global Asset Management (UK) Limited only and are subject to change without notice
HSBC Global Asset Management (UK) Limited has based this piece on information obtained from sources it believes to be reliable but which it
has not independently verified. HSBC Global Asset Management (UK) Limited and HSBC Group accept no responsibility as to its accuracy or
completeness.
This presentation is intended for discussion only and shall not be capable of creating any contractual or other legal obligations on the part of
HSBC Global Asset Management (UK) Limited or any other HSBC Group company. Care has been taken to ensure the accuracy of this pres-
entation but HSBC Global Asset Management (UK) Limited accepts no responsibility for any errors or omissions contained therein.
Please note that past performance is not a guide to future performance.
Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC Global Asset Management (UK)
Limited accepts no liability for any failure to meet such forecast, projection or target.
This document is issued in the UK by HSBC Global Asset Management (UK) Limited authorised and regulated by the Financial
Services Authority.
www.assetmanagement.hsbc.com/uk