Friday, 4 March 2016

The importance of active management in emerging markets.

Investors in emerging markets would be well placed to take a discerning approach to both sector and country allocations in 2016 given current volatility and uncertainty.

The reality for emerging markets is one of a highly differentiated backdrop where opportunities do remain plentiful but only for those willing to be active in their asset allocations.

This generally means an underweight in financial services and significant overweight exposure to the healthcare and consumer sectors. Energy, materials, and industrials, likewise, are substantially underweight in an active strategy.

It’s not the emerging markets universe of 10 years ago where a rising tide was floating all boats – and that means you have to work all the harder to identify value and to avoid the risks. The index is one with significant commodity-related exposure which hides some very attractive growth opportunities.
In financials, the strategy’s sector allocation demonstrates this discriminating approach. Even though exposure to the sector overall is below that of the comparative index, holdings in life insurance companies are a key part of the portfolio, including through Hong Kong-headquartered insurance company AIA.

AIA and its UK-listed peer Prudential have product ranges targeted specifically at the Asian market and so have witnessed high rates of new business growth as countries in the region become wealthier and the number of middle class consumers has increased.

Even so, insurance penetration rates remain low and this means the scope for future growth remains high. In Indonesia, for example, the current life insurance market would be 64 times bigger than it is today if penetration rates were equivalent to those of the UK. By the same measure, China’s would be 31 times bigger.

On a country view, there is an element of misinterpretation about China’s growth prospects by the financial media as the economy rebalances away from commodities and primary industry and further towards consumption.

While there has been a decline in GDP growth, this has largely been caused by a deceleration in primary and secondary industries. Tertiary industry, by contrast, has performed far better, remaining more or less stable since 2012, albeit with a marginal decline.

Elsewhere, India offers opportunity after more than four years of pent-up demand during the economic slowdown preceding the election of prime minister Narendra Modi in May 2014.
The new government’s been doing the right thing and we’re beginning to see stronger growth coming through. The country benefits from positive demographics, and low credit penetration and that helps underline the investment case even as far as the potential for growth in things like car ownership.
Finally, consider the power of demographics to drive future growth, most significantly through changes in the working age population. According to UN estimates, the likes of Malaysia, the Philippines, Peru and India are forecast to see significant GDP tailwinds between 2011 and 2035 as their working age populations grow.

In contrast, developed countries such as Japan and Germany are expected to see sharp declines in the number of people in work over the same period – and this will likely create a drag on GDP growth. In terms of their productivity potential, emerging market countries are generally in a superior position versus their developed market peers.

But even here, a discriminating approach is important, he says, noting that Russia, Korea and Thailand – all of which sit in the emerging markets universe – are expected to experience a decline in their working age populations of between 10-15% between 2011 and 2015.

It underlines the point that not all emerging markets are the same and that active management is the key. As always, consider opting for high quality investments with a focus on income producing assets and seek advice where appropriate.

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