Fear and loathing in emerging markets
Will the headwinds in the developed world cause emerging market economies to underperform? How do investors balance the positive tail winds from demographics from emerging markets alongside the head winds in developed markets? And, given the historic returns and volatility, are emerging markets worth the risk?
These were just some of the questions raised during a panel discussion on “Fear and loathing in emerging markets: Is it worth the risk?” at the Fiduciary Investors Symposium with the audience questioning whether the investment proposition for emerging markets remains sound.
Panelists discussed whether the growth story for emerging economies was valid since the stark truth is the developed countries delivered more growth in the past five years than most emerging economies.
However, many emerging markets still promise sizeable returns for asset owners because of the favourable demographics, delegates at the conference heard.
Mark Burgess, investment committee chair of HESTA, the $50 billion fund for health and community workers, argued that demographics for emerging markets are positive, but weak for the developed world.
“Effectively, you have a long and a short trade and you can’t ignore it because it’s happening both ways…. asset prices change with negative demographics,” he said.
“You’ve got a dynamic on the developed world side which you have to consider against the dynamic on the emerging economies side.
However, Burgess conceded there was a “ripple” in the story – that very young populations are naturally volatile. “For instance, people forget that Japan was volatile in 1950 because it had a youth surge that it couldn’t employ properly,” he said.
“So, demographics may be positive but the transitional aspect of it may be challenging,” he argued.
The HESTA investment committee chair said it was important for investors considering such investment to look these economies in a historical context.
Historically, he said, emerging markets have been successful because they exported to the developed world, which has now seen a peak in population growth.
Burgess further argued if the global economy slows down, there is a question mark over whether emerging market economies around the world – struggling with lower-than-expected growth – can drive enough growth internally to be successful.
ANZ Wealth CIO Mark Rider predicts the internal domestic demand story is likely to continue to drive growth especially with the rise of consumer consumption in China, and technology.
When looking at the case for the emerging markets, he went on to say the general story was always that the lower income economies were going to catch up with the developed world to generate positive excess returns.
“Yet with the exception of China, economies have not caught up so investors have missed that opportunity. Emerging markets typically been more volatile than developed markets whether through a commodity or currency crisis and drawdowns have been significantly greater than in developed markets. As such, emerging markets have a significantly lower Sharpe ratio than the developed world.”
“Given these markets account for more than 55 per cent of the global population, they should some extent be masters of their own destiny. But since the global financial crisis they still remain hostage to the external constraints.
Panelists agreed the capital structures markets leakage of return on non-public investment to the state in certain countries – are problematic although Scott Tully, general manager of investments at Colonial First State Investments, reminded delegates that that markets don’t necessarily deliver the same outcomes as economies
“When we talk about emerging markets underperforming that’s by a beta perspective rather than through looking at different investment strategies. Perhaps when you sort through the portfolios that people invest in, you get a different perspective on outcomes than when you look at markets,” added Peter Laity, a former head of equities at TCorp.
Panelists also noted that emerging markets have generated solid returns on debt for investors. The main Bloomberg- Barclays debt index for the emerging economies, including both government and high-grade corporate debt, has easily beaten the equivalent US index since the year before the global financial meltdown.