Structural factors and superior growth mean investors cannot ignore EMs, says UBS strategist
Justin Wells, equity strategist Emerging Market Equities at UBS, notes that structural factors such as demographics and growing consumption coupled with economic growth mean investors in developed markets cannot ignore emerging markets.
Wells expects the trend of inflows to emerging market equities to continue.
Structural factors cited include the demographics and consumption growth patterns developing in emerging markets, which offer investors access to overall growth rates superior to that found in developed markets, particularly in Europe.
Investors cannot ignore the numbers suggesting that 60% of the world’s population is in Asia, some 4 billion people, and that 40% of these are under the age of 25, Wells said.
More recently, while there have been roughly two quarters of relatively benign activity in developed markets, there is still significant ongoing deleveraging of governments, corporations and individuals. Interest rates are tepid and investment returns have been low. That type of environment makes high yield or equity type products attractive, he says. And a good way to access higher return is from emerging markets.
Meanwhile, emerging markets have been building themselves up as bone fide sources of income. In the past decade there has been a significant change in the number of companies paying a 3% yield – a fourfold increase in billion dollar companies paying dividends at this level, Wells said.
And despite the global financial crisis that hit in 2008, many companies in emerging markets retained a dividend discipline that some may have found surprising. Looking forward there is also an additional upside for investors in emerging market income, Wells added: corporate debt levels are in many cases lower compared to developed market peers, while dividends ratios are still slightly lower; this increases the potential to pay more dividends in future.
Currency is an issue for any investor in emerging markets, but Wells suggests that it is not such a challenge that it is worth giving away some return in order to hedge out currency risk.
The funds that Wells and his colleagues work on do not use currency overlays. Rather there is a feeling that emerging market central banks have implemented measured policies. That said, he admits that currencies remain volatile, and the levels of central bank intervention around the world remain unprecedented, possibly pointing to a future need to discount for currency valuations.
But in another sense currency is becoming less important in the overall global emerging market equity story. China is engaged in a huge shift towards more domestic driven growth and less reliance on exports. In turn that suggests that the ability for RMB to exhibit severe volatility, thus destabilising returns, is diminishing over time.
Play local or developed stock markets?
Wells says it is a moot point as to whether it is better to access emerging market equity investments via local stock markets or via those in developed markets.
He notes that this is, for example, an ongoing debate in the area of investments focused on consumption led opportunities. There are different ways of doing things, different ways of investing, he said. In UBS’ case it is focused on developing strong local presence, including in the shape of the portfolio managers and strategists themselves coming from different emerging markets. They may even have worked locally in the sectors they now cover on behalf of UBS and its clients.
“The value-add is in being local and on the ground, to see trends unfolding,” he said.
Local markets are becoming more professional in their operations, which is helping emerging market investors such as UBS, Wells continues. An example would be Singapore, which has developed the skills and access to global infrastructure required to support local listings in a way that equals what may be found in any developed market.
However, Wells warns: “It is not binary, it is complex”. There are examples of multinationals finding it hard to make inroads into emerging markets for any number of reasons, including issues of supply chains, logistics, or even high levels of customer loyalty to existing domestic franchises and/or brands.
In such cases, UBS will see value in investing in companies it feels are local and providing goods and services to local consumers. This does affect stock selection, but so does the realisation that local companies may be at a certain stage in their development where they are less likely to provide income in the form of dividends, because they are more focused on areas such as R&D, rather than returning cash to investors.