Wednesday, 28 December 2016

Back to BRIC (Part Two)

Following last week’s article regarding the BRIC economies, I received emails from clients curious to know just how strongly I believed in BRIC and more specifically what statistics I could show to suggest that recent improved performance of emerging market countries would continue.  As a result I decided to follow on from last week’s article and go into a little more detail regarding some of the key economic factors behind the scenes.
The drivers of emerging markets underperformance over the past several years, such as uncertainty over US Federal Reserve interest rate policy, US dollar appreciation, global growth prospects, and declining commodity prices, appear to be dissipating.  Even with the strong performance of 2016, I believe that emerging markets still have room to run. Compared to developed markets, emerging markets equities have similar profitability levels but are much less expensive, and I believe it is an opportune time to consider an allocation to emerging markets stocks for the medium term. (Note: allocation and medium-term are key)
Here are the main reasons why:

-       Improving Current Accounts
After peaking in late 2007, current account balances in the emerging markets deteriorated as global growth and trade slowed. Since 2013, however, these current account balances have improved. In 2016, emerging markets export growth has increased due to higher oil prices and some stability in the US dollar.
-       Superior Debt-to-GDP Ratio
While US dollar–denominated debt has increased in both emerging and developed markets, emerging markets debt to GDP is still less than half that of the US and lower than both the UK and eurozone. Importantly, China has driven the majority of the debt increase in emerging markets. When China is excluded, emerging markets have relatively stable debt to GDP.  Investor fears about a Chinese credit crisis may be unwarranted, and although China’s debt to GDP remains high it is still lower than that of those in the developed markets, including the United States and Europe. In addition, China’s shadow banking system is less than 50 per cent of GDP, compared to the United States and the euro zone, where shadow banking exceeds 150 per cent of GDP. The growth of non-performing loans (NPLs) has accelerated in recent years, but considerable work has been done to manage NPL formation, including provisioning, restructuring, and writing off bad loans. We are encouraged that most of China’s debt is issued in its local currency.
   
-       Attractive Yields
After the financial crisis many emerging markets central banks tightened policy, while central banks in the developed markets cut rates and implemented bond-purchase programs, pulling yields toward the zero-bound, or even into negative territory. As investors continue to hunt for higher real yields globally, they have been migrating back to emerging markets assets across fixed income, currencies, and high-dividend equities.

-       Lower Inflation, Higher Growth
Over the past few years, several emerging markets have been plagued by inflation, which has hindered their economic growth. Recently, however, inflation has slowed across emerging markets, allowing for a more accommodative central bank policy. While emerging markets currency appreciation against the US dollar has helped reduce inflation, we believe the key drivers have been weak capacity utilisation, growth, and pricing power.


In conclusion, after an extended slump, emerging markets have rebounded strongly in 2016. However, relative valuations have not changed significantly as emerging markets equities remain inexpensive compared to other global equities. For 2017 (and beyond) I see emerging markets as an exciting opportunity as part of a well-balanced portfolio that will provide access to some relatively cheap company equities, many of whom continue to show string and resilient profitability.

Wednesday, 7 December 2016

Back to BRIC?

Coined by former Goldman Sachs chief economist and ex-UK government minister Jim O’Neill in 2001, the BRIC bloc of Brazil, Russia, India and China was supposed to represent the fastest-growing emerging economies outside of the G7 group of western developed economies.  Yet the investment case for the feted BRIC economies has been overshadowed in recent years by the poor performance of the Brazil and Russia equities markets. While Chinese and Indian markets have continued to deliver strong returns, sanctions-hit Russia and politically turbulent Brazil have lagged their counterparts.
Over the past three years, the MSCI India index has generated a return of 52.70% and the Chinese index is up by 32.28%.  Brazil, meanwhile has managed just 0.20% growth and the Russian index is down by -1.54% during the same period.
However we may be about to see a shift.  In its outlook for the G20 group of advanced economies, the OECD has forecast real GDP growth of 7.6% for India and 6.4% for China in 2017. After difficult years for the Russian economy following the imposition of sanctions, real GDP is expected to expand by 0.8% during 2017, and Brazil too is expected to emerge from the economic doldrums with flat growth after difficult years for the South American economy.
Sentiment toward emerging markets continues to become more positive as many investors look for higher yields and the risk perception toward the asset class improves.  A rebound in emerging-market currencies, easing concerns about a hard landing in China, attractive valuations and robust economic fundamentals in many economies are some of the factors that have continued to support the performance of emerging markets.  GDP growth in many countries has also been slowly improving, and over the next few years, countries like Russia and Brazil could see the biggest relative improvements.
As two of the largest and fastest-growing economies of the BRIC bloc, China and India continue to offer many opportunities to investors.  Three funds in the Investment Association universe have at least 25% exposure to India and China and have outperformed the MSCI BRIC index over the past three years.  Fidelity’s £878m Emerging Asia fund – which has a 31.1% weighting to China and 34.7% of its portfolio in Indian stocks – has returned 50.84% over three years. 
Of the dedicated BRIC funds in the IA universe, the HSBC GIF BRIC Markets Equity fund has been the best performer over the past 12 months, delivering a return of 43.44%, compared with a 24.49% rise for the average IA Global Emerging Markets fund.  However, the HSBC fund had a poor 2015 making a loss of 17.77% compared with a fall of 13.46% for its composite benchmark. It has an annualised return of just 0.82% over three years.  The $765m (£614.6m) Templeton BRIC fund has returned an impressive 33.08% over the past year. Yet, the fund also struggled in 2015 after reporting a 10.25% loss, compared with only a 8.23% contraction in the MSCI BRIC index.  It would seem that historical highs within BRIC markets have been short lived.

So why is now the right time for investors to return?  Well there are a number of reasons.  The recent rise in commodity prices, a cautious US Federal Reserve  boosting emerging market currency strength, post-recession leading to improved economic stability (Russia and Brazil), and increasing political momentum in key EM economies all suggest now could be an opportune time for investors.  No question that some of the volatility and uncertainty will remain, but on balance the future for these emerging markets has to be bright.  Relative to stocks in developed countries both on valuation and risk basis, companies in Asia are at the bottom of the earnings cycle and expected by many to deliver better earnings growth in 2017.