The traditional argument for investing in emerging markets (EMs) was compelling. Their economies were growing fast from a low base. Growth was initially based on commodities and basic industries but, in time, countries would move up the value chain, as Asia had demonstrated.
Young populations meant plentiful cheap labour. The growth of the middle class opened opportunities for businesses that were mature in the developed world. Initially, investing was as easy as “BBC” – banks, brewers and cement – but new technology in areas such as mobile communications would enable countries to cut corners to achieve prosperity, saving on expensive infrastructure.
Crises have hit returns
Dan Rasmussen of Verdad Capital shows that it hasn’t exactly gone according to plan. “Over the past 30 years,” he says, “buy-and-hold investors in emerging markets [as measured by the MSCI Emerging Markets index] have endured high volatility for disappointing returns: $100 invested in the S&P 500 index in 1989 would be worth $1,900 today compared with $1,340 if invested in EMs where volatility has been 50% higher.” The reason for this is EMs’ frequent crises. “Since 1989, there have been more than twice as many EM crises with [declines of] over 50% than in developed markets. Even worse, EMs have been less likely to recover from crises.”
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The global economic realignment towards larger emerging markets “never translated into equity returns”. Average annual economic growth in EMs in those 30 years, according to the International Monetary Fund, was 4.7%, compared with just 1.8% for developed economies.
“When crises occur in developed markets... investors never doubt that a government bond will safely store capital, that the political system is stable or that water will continue to run from the tap.” But emerging economies might default, the political system can be uprooted and “the question is not when but whether the economy will truly recover”. For example, the Philippines’ index has never returned to its 1997 peak. The flight of not just foreign but also domestic capital to safe havens worsens crises.
Buy after heavy falls
Despite such examples, Rasmussen finds that EMs usually recover from seemingly hopeless crises making a strategy of investing in EMs that have fallen by more than 50% highly profitable on average. In two thirds of examples, the average return over two years was 89% but in one third, -31%. Such a strategy would recommend BlackRock Latin America (LSE: BRLA) and BlackRock Frontiers (LSE: BRFI), both down by over 50% a year ago but still 32% and 28% from their highs. The managers of both trusts are highly confident.
An alternative strategy would be to pick a trust whose great record of stockpicking insulates investors from lacklustre emerging markets indices. The JPMorgan Emerging Markets Investment Trust (LSE: JMG), with £1.6bn of assets, has outperformed the MSCI EM index by 37% over five years while the Templeton Emerging Markets Investment Trust (LSE: TEM), with £2.6bn of assets, has outperformed by 50%. JMG has outperformed in eight of the last ten years, so its shares trade at net asset value (NAV) while TEM’s are on a discount to NAV of 5%-6%.
Both trusts are heavily invested in “new economy” sectors such as information technology, communication services and consumer stocks rather than commodities and industrials, “paying a premium for high-growth, high return-on-equity businesses”, in the words of JMG’s manager Austin Forey. “There are as many opportunities now as in the last ten years,” he says. Andrew Ness, co-manager of TEM, says the outlook is “compelling, with corporate earnings set to rebound sharply”.
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