Laurent Deltour, Chairman, Sycomore Asset Management

Emerging market equities: an asset-class that remains attractive, as long as you are selective

The global economy can’t afford to wait any longer for euro zone (in)decisions. European stagnation is increasingly worrying US officials as well as those in the emerging markets. Given that Europe remains the major trading partner for both China and the United States, the economic slowdown of our economies has serious consequences for global growth prospects, says Laurent Deltour (pictured), Chairman, Sycomore Asset Management…

Many economists, including GaveKal Dragonomics’ chief economist Andrew Batson, are predicting that Chinese economic growth may be lower than 5% in the future. At the same time, emerging market growth should be significantly superior to growth in the euro zone, which is estimated to be an average 1.4% in 2012.

There are good reasons why an investment in emerging markets still has its supporters: the demographics of the region, the rapid growth of the middle class and rapid urbanisation, all continue to drive internal demand during a period when slower growth in developed nation economies obliges the emerging market economies to rebalance their own growth model. The model that is emerging is less dependent on exports and more oriented towards domestic market drivers.

In general terms, emerging markets have significant margin to manoeuvre in terms of both fiscal and monetary policy. Having gained credibility in recent years, the central banks are now more responsive to changing economic conditions and many emerging economies have already implemented monetary policy stimulus. Moreover, infrastructure development has improved the potential of the governments to mitigate inflation risks and better manage their territories.

The potential value of listed companies in these countries is far from being realised. On the one hand, emerging markets are still marginally underweight in terms of investment flows given their weight in the global economy, and moreover, their contribution to global economic growth. On the other hand, the rapid development of these markets has been accompanied by increasing liquidity, the emergence of large local institutional investors and unprecedented growth in the number of equity investment options. Chinese companies alone accounted for nearly half of all the new funds raised on global stock markets in 2011. It is reasonable to expect that IPOs will make their comeback in Brazil in the coming months. Finally, the region’s poor performance in 2011 has reinforced its attractiveness.  Despite a rally at the start of this year, the MSCI Emerging Markets (MSCI EM) index remains 40% below its level of October 2007, and that, despite a significant rise in the earnings power of local companies over the period. Consequently, the average company P/E ratio for 2012 is less than 11 in Asia, is below 10 in Brazil and about 5.3 in Russia, all despite attractive growth in earnings per share.

The question remains: how to invest in these markets? Those - a growing number of investors - who see this asset class in terms of long-term choice, should focus on highly selective funds, the exact opposite of ETFs strategies (Exchange Traded Fund). Emerging markets are very heterogeneous both between regions and market segments. Investing in listed companies in these markets requires fundamental analysis based on thorough research and an intimate knowledge of the businesses combined with access to the thinking of their management. Additionally, the investment processes must be applied with composure and discipline by experience managers who have already experienced crises like we are seeing in the euro zone. A long-term local presence is a real source of added value.

Emerging markets are not the Wild West they were a few years ago. Now, highly regulated, liquid and diversified, they are well suited to a stock picking approach based on valuation criteria. Further evidence that they have emerged into normality. 

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