Active EM managers see opportunity despite capital outflows

Emerging markets are experiencing strong capital outflows during Covid-19 and this is to be expected of risk asset classes during “risk-off” environments, but history shows these periods of outflow are often followed with strong returns, according to UBS Asset Management’s head of emerging markets and Asia Pacific equities.

Speaking at Investment Magazine’s Fiduciary Investors Digital Symposium, held online between May 19 and 20, UBS’s Geoffrey Wong said emerging market investments, as a risk asset class, experience periodic outflows during “risk-off” environments such as what is being seen now with the spread of Covid-19.

But following these periods of outflows, Wong said, emerging market investments often see strong subsequent returns. Looking at the MSCI EM Index, the last four episodes of capital outflow were followed by on average 30 per cent gains in the following 12 months.

While over the last ten years, EM returns have been unfavourable, in the last 35 years EM has returned about 9 per cent per annum in US dollars, Wong said, putting it slightly below the S&P500 but significantly above other developed markets.

“So EM, yes, there is more risk, but certainly the return has been there,” Wong explained. “It’s not necessarily better than US equities, but certainly the return is enough to justify a position in a diversified asset allocation.”

However, it’s important to invest actively rather than passively, Wong said, with actively managed UBS EM strategies far outperforming passive indexes.

“There are not many places where you have market inefficiencies still in liquid investments and emerging markets is one of them. So EM is one of those places where you need to stay active even if you choose to stay passive in other major equity asset classes.

The global pandemic had opened up large gaps in performance between emerging markets, Wong said. The Chinese market is performing comparably with the United States while markets of countries perceived as more vulnerable to Covid-19 are down 30 to 40 per cent.

“If your active manager is able to identify the winners and avoid the losers, you should expect 3 or 4 per cent active return, which is something that is very hard to achieve in the S&P500, for example,” Wong said.

Large emerging market companies are, as a whole, accumulating cash on their balance sheets while US companies typically don’t have a lot of cash due to share buybacks, he added.

Emerging markets also have more room for both fiscal and monetary stimulus compared to developing markets, Wong continued, with some notable exceptions.

Using price-to-book figures, valuations of emerging market companies are very low, Wong said.

“We are at valuations which have basically only been at previous major recessions such as the GFC in 2008. We are at just about the lowest valuation of the Asian Financial Crisis and the Russian Financial Crisis in ’97 and ’98.”

Emerging markets are facing a lot of challenges with the spread of Covid-19, Wong said. “Some of the lower income ones will certainly have a harder time dealing with… the medical and humanitarian side of this crisis. But on the flip side, the large companies are pretty healthy, some of them are doing quite well, and a few selected ones are actually benefiting from this, especially those with a strong online presence.”

Chair Alex Proimos, Head of Institutional Content for Investment Magazine, asked about the key themes driving EM returns.

Wong replied that a major factor is trends in consumption. When incomes grow to a point consumers start buying discretionary items, insurance and other products, investors begin to receive large returns.

Technology is also a major factor, with leading technology companies now coming out of emerging markets in areas like 5G, semi-conductors and artificial intelligence.

Companies that tap into trends to do with “financial deepening” often grow faster than GDP, Wong said, as consumers in lower income countries begin to obtain bank accounts, get credit cards and take out housing loans.

As supply chains are rebuilt after Covid-19, supply chain diversification will be an ongoing theme, he added. This will help companies involved with factory automation, artificial intelligence and robotics as factories are rebuilt with new technology.

Ben Hurley is a journalist and editor with more than a decade of experience in the industry. He has written for The Australian Financial Review, Business Review Weekly, The Guardian and a range of specialised and industry publications.
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