After several years of underperformance, emerging markets appear to be back. Emerging markets equities have outperformed developed markets in 2016, despite rising market uncertainty and the results of the U.S. presidential election. The rebound is due to a number of factors, including stabilizing commodities prices, dovish rate policies, and improving fundamentals. In addition, consensus on the asset class has swung dramatically over the past 12 months as investors have grown increasingly desperate for yield at a time when some policy rates in Japan and Europe have dropped below zero.
We believe the emerging markets rally is still in an early stage. Emerging markets performance has been lackluster over the past five years, leaving equities at cheaper valuations than many developed markets. Prospects going forward are improving. Economic growth, for one, has started accelerating recently and, importantly, corporate earnings are up. Today, emerging markets have generally improved their current account balances, with lower exposure to foreign currencies and debt. Many emerging markets companies appear to be stronger and better governed, and many have in fact benefited from lower commodities prices. Over the longer term, emerging markets continue to offer favorable demographics, growth potential from technological and infrastructure development, and rising consumption.
This raises important questions for financial advisors and their clients. How should they access this opportunity? What are the best ways to build exposure across emerging markets asset classes, including equities, fixed income, and currencies? (For related reading, see: Emerging Markets: What Advisors Should Tell Clients.)
Tapping Into Emerging Markets
It is important to first note that emerging markets are hardly a homogenous asset class. After 30 years of significant but uneven growth, emerging markets are diverse and offer a range of investing characteristics—often with significant performance dispersion between markets. We believe a tactical multi-asset approach can take advantage of this diversity. It can implement a nuanced, dynamic strategy, delivering a targeted risk/return pattern that can be tailored to the individual investor’s needs and goals.
Managers today have broader opportunities to exploit growing country and sector performance potential across growth, value, core, blend and other style factors in emerging markets. For example, smaller companies tend to focus more on domestic consumers and may have less debt, making them less susceptible to global shocks compared to larger firms. Growing companies can potentially offer higher returns but often come with higher risks. Established companies may have lower growth profiles, but they can deliver higher yields or trade at more attractive valuations, offering support in volatile markets. Small, growing, and established companies all benefit from different business environments.
Currencies can be valued as a broad reflection of a country’s macroeconomic fundamentals and generate uncorrelated returns, improving diversification benefits. An emerging markets currency portfolio can benefit from periods when macroeconomic positions strengthen, local rates increase, or global investors move into emerging markets assets. Currencies can decline when monetary policy in emerging markets eases or global fund flows are attracted to developed markets. (For related reading, see: Which Emerging Markets Win and Lose Under Trump?)
Emerging markets debt spans a broad spectrum of local currency, hard currency, corporate, sovereign, and quasi-sovereign bonds. The keys to success in this asset class lies in identifying market or pricing inefficiencies and capitalizing on them across several different instruments. Skilled managers can blend these emerging markets asset classes to try to mitigate idiosyncratic country and company risks. This approach can help address investor concerns about volatility and instability associated with emerging markets. Apart from potentially smoothing investment returns, such diversification can lower entry point risk—a concern for some investors after this year’s rally in emerging markets.
At the same time, such strategies can offer the opportunity for exposure to market gains. Emerging markets remain inefficient in many ways that skilled managers with local resources and perspective can attempt to exploit. A multi-asset allocator can look to take advantage of mis-pricings at the asset class level while engaging the best active managers for security selection. This also avoids the challenges of passive investing in emerging markets, given the performance dispersion between countries and the inability to target specific corporate investment opportunities.
Ultimately, the success of multi-asset investing depends on the individual manager. Look for managers who have demonstrated success over time and the global resources necessary to exploit the broader emerging markets opportunity. In this way, investors can benefit from a strong asset allocation process as well as traditional security selection. (For related reading, see: These Will Be the World's Top Economies in 2020.)
Director, Portfolio Manager/Analyst
Lazard Asset Management LLC (New York)
Rupert Hope is a Director and Portfolio Manager/Analyst on the Lazard Multi Asset investment team. Prior to joining Lazard in 2014, Rupert was a Managing Director and Co-Head of Global Equity Distribution at Renaissance Capital. Previously, Rupert was at Deutsche Bank where he served as a Managing Director, running various emerging markets equity teams across the global platform. He has been involved in global finance and investing since joining Baring Securities in 1994. He has a BA (Hons) in history from the University of Durham and holds a global executive MBA from TRIUM (NYU/LSE/HEC).
Information and opinions have been obtained or derived from sources believed by Lazard to be reliable. Lazard makes no representation as to their accuracy or completeness. All opinions expressed herein are as of the date of this communication and are subject to change.
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