Invest where the growth is
Emerging markets are still cheaper than developed ones, and you should have at least 20 percent of your offshore portfolio exposed to these markets, an emerging market fund manager says.
Anwaar Wagner, the manager of the Old Mutual Global Emerging Market Fund, told a recent Old Mutual Investment Group South Africa (Omigsa) conference that economic growth in emerging markets is outpacing that of developed markets and will do so for many decades.
Citi Investment Research and Analysis predicts that many emerging regions will show economic growth of more than four percent a year until 2050, while economic growth in developed markets is likely to be around two percent a year until 2050, Wagner says.
He also says the valuations of certain emerging market shares based on their expected earnings are still cheaper than those of shares in developed markets.
The valuation of a share is its price relative to its earnings (which are based on company profits). This is measured by a share’s price-to-earnings ratio, or p:e.
Wagner says, in US dollar terms, developed market equities had a lower return than emerging market equities for the decade 2000 to 2010.
But this was not the case from 2010 to 2012, partly due to the unprecedented monetary and fiscal stimulus provided by advanced economies, making emerging markets more attractive on a valuation basis and providing an attractive entry point to gain or increase exposure to emerging markets.
He says developed countries have used up all their “firepower” to stimulate their economies: they have increased their government debt significantly, they have cut interest rates to almost zero, they have weakened their currencies, and they have printed money like there is no tomorrow.
Emerging countries have, by contrast, much less debt constraining their economic growth and room to cut interest rates, Wagner says.
The contribution of emerging and developing market economies to global growth is expected to overtake that of advanced economies this year, and, as an asset class, emerging markets will be too big to ignore in future, Wagner says.
Global equity indices are, however, still weighted in favour of developed markets, he says.
Wagner says some shares in emerging markets, particularly those of companies that produce consumer goods, are becoming expensive relative to the book value of the company.
Wagner says that while these shares are generally good quality companies, most of them have become expensive. In emerging markets, however, there are other companies offering exposure to the emerging consumer that are valued more attractively.
He cites Hyundai and Samsung, which have strong brands, are expanding their market share rapidly and yet are trading on low p:e’s of six and eight respectively.
Wagner says there are over 4 000 emerging market shares from which his fund can choose and about 600 quality shares among these.
Within that universe, he says, fund managers have to find the shares that are priced right, but if they do, they will be rewarded, because many emerging market countries have good fiscal discipline, positive growth in their demographics, strong trends of the urbanisation of rural people, and cheap labour.
All of this bodes well for shares that are priced well, he says.
US SHARES ‘OFFER GOOD VALUE’
An asset manager based in the United States has argued the case for investing in US equities.
Cory Martin, managing director of Barrow Hanley Mewhinney & Strauss, a Texas-based investment company that manages assets for some Old Mutual Investment Group SAportfolios, says it has been very difficult for active fund managers to deliver returns better than those of passively managed investments in recent years.
He says there has been a convergence of returns from both developed and emerging market shares since the global financial crisis in 2008, and around the world this has resulted in value-style managers – who invest in shares with low valuations – delivering poor returns relative to market indices.
However, Martin says, his company believes this is changing – particularly so in the case of US equities.
He says the key advantages for US manufacturing companies are that their labour market is stable and the costs are restrained, while there have been big increases in emerging market labour costs.
In addition, he says, the US has abundant energy, the dollar is weak relative to other currencies, US companies have transparent accounting systems, the country has a well-developed infrastructure, and it has deep and liquid markets in which to raise capital.
Martin says US companies have been holding a lot of cash while waiting for the outcome of the US presidential election and because of uncertainty surrounding the “fiscal cliff” – the potential for tax increases, cuts in government spending, and reaching the US debt ceiling.
He says companies have cut their operating expenses to improve their profit margins and, as a result, have built up a lot of free cash.
Last year, US companies paid a lot of this free cash back to investors in the form of dividends and share buybacks because they did not want to hire new staff and embark on new projects in the midst of the uncertainty, Martin says.
Dividends, he says, have contributed half of the 9.8-percent average annual return earned by the S&P500 Index (the index of the top 500 US shares) since 1929.
Martin says many large companies on the S&P500 Index increased their dividends by between 10 and 40 percent over the past year. Despite this, the valuations of these shares remains attractive.
He says while these peak levels of profitability cannot be sustained and profit margins will come down, it will still be possible to earn high single-digit returns on US shares.