EM a hard lesson in 2013 says Wells Fargo AM’s Derrick Irwin
Investors need to think about individual companies and individual markets when investing in emerging markets, rather than following themes, urges Derrick Irwin, portfolio manager at Wells Fargo Asset Management.
Irwin has put forward this and other points in an interview seeking his views on the challenges and opportunities facing emerging market investors.
How have you had to react to changing fortunes for emerging markets (EM) equities through the past year?
The biggest shift in emerging markets equities in 2013 was the change in focus from certain growth sectors, such as consumer and information technology, to differentiation at the country level. In the early part of 2013, investors were assuming a long period of low growth, low interest rates and low inflation. After May, investors began to anticipate a more normalised global liquidity environment. Countries with large current account deficits, which may be challenged to secure funding in such an environment, were largely shunned. Instead, investors focused more on countries with sustainable current account surpluses. Our investment process has long attempted to look past the inevitable adjustment in global liquidity conditions, which means we did not make significant changes to the portfolio.
What new lessons do you feel EM equity investors have learned from events?
Few, if any. Investors seem to focus on one overriding theme at a time instead of looking at individual business models and how good companies manage their unique business environments. We continue to see certain parts of the market become over-valued, whilst strong companies in the wrong sectors or region languish. This eventually creates distortions in valuation that we hope to take advantage of.
How can these lessons be implemented through 2014?
The focus on country fundamentals, mentioned earlier, is somewhat justified and has been part of our analytical framework for some time. However, should investors take this too far and ignore underlying business fundamentals, we would expect valuation opportunities to occur. This is what we will be watching for in 2014.
There is a growing consensus view that 2014 will be a year for picking out single-country EM opportunities: do you agree, and if so, which EM would you pick out?
It seems likely that some countries will be more successful in addressing the key structural headwinds than others. We are encouraged by the progress that India and Mexico have been making, and we’re also hopeful that Turkey will emerge a winner as well. China is a wild card, given the ambitious reform agenda the government has laid out, but we think it is attempting to lay the foundation for long-term sustainable growth. The question is how much turmoil will reforms cause in the meantime, and can the Chinese government tolerate the inevitable instability?
Do you have a particular view on how US Federal Reserve (Fed) tapering of asset purchases could take place and the effect on EM equities as an asset class?
We don’t allocate capital based on macroeconomic forecasting. Although the Fed has announced plans for quantitative easing tapering, we are looking through the inevitable near-term volatility that such a move will likely create. Ultimately, a more sustainable global liquidity environment, coupled with stronger growth in the US, Europe and Japan, will be positive for emerging markets equities. However, significant distortions in the global economy have built up as a result of high levels of global liquidity, and as these unwind, we expect markets to be volatile.
Have the long-term benefits of investing in EM equities changed or not, and either way, what is your long-term view?
We remain positive on emerging markets equities in the long term. In general, corporate and sovereign balance sheets are in good shape (with notable exceptions, of course), growth remains robust and many countries are now embarking on long-needed reforms that had been ignored over the last several years.
Whilst it is dangerous to view emerging markets as a single entity, as a whole, they are trading at a significant discount to developed markets, whilst earnings trends appear to be improving. Looking forward, it will be important to distinguish between countries, sectors and companies, as returns are likely to be more dispersed. Also, once the volatility surrounding the Fed’s tapering of asset purchases subsides, we believe that investors will focus more on company fundamentals, as opposed to macroeconomic factors that have driven returns in the last several years. High-quality business models should produce strong returns over time.