Theres a new buzz sweeping through emerging markets.
Fundamentals are improving, and valuations look attractive.
Returns and flows are showing signs of life. For investors who
have been underweight, emerging-markets assets now look very
Peru to the
Philippines, today investors can find an array of
countries, companies and currencies that offer promising return
potential. Before jumping back in, however, its important
to consider what has changed after several tough years.
In the past, investors could succeed by riding the so-called
beta trade, as emerging-markets equities and fixed income
delivered powerful returns over time. Today, though, without a
rising tide to lift all boats, investors can no longer rely on
a broad market recovery to drive returns. As a result, we at AB
think its essential to stay active in emerging markets
and take a highly selective approach to creating portfolios
that can deliver long-term outperformance. Its also
important to move away from
emerging-markets benchmarks, which are backward-looking and
dont reflect the most promising future investment
Stocks and bonds have both recovered sharply in 2016. During
the first eight months of the year, the MSCI emerging-markets
index advanced by 14.8 percent, outpacing developed equities.
In fixed income, the J.P. Morgan emerging-market bond index
rose by 14.6 percent over the same period. After the large net
outflows in 2015, investors have been adding money to
emerging-markets funds again in 2016. Asset allocation funds
have started to gradually increase their exposure to emerging
markets and for good reasons. They are:
Overall GDP growth across emerging
markets has slowed from the breakneck pace of several years ago
but appears to have stabilized. Commodity prices have started
to rebound, helping support more resource-dependent countries.
Corporate earnings are forecast to grow by 6 percent in 2016
(see chart 1), according to consensus estimates, versus flat or
negative growth in many developed markets. Earnings growth is
already playing a big role in this years equity
Inflation remains well contained in
most emerging economies, and the recent stabilization of
exchange rates could provide room for additional stimulus.
Current-account positions are
improving from the lows seen in 2013.
Political risks cant be
overlooked, but there are encouraging changes taking place in
various countries, such as Brazil, Argentina and India, that
should further boost investor sentiment.
Investors are paying attention to these improvements.
Following the outflows in 2015, new capital has started to flow
back to both stock and bond funds that focus on the developing
world. Still, most global investors remain underweight, after
reducing their allocation to emerging equities in recent years
(see chart 2).
Attractive valuations are providing another catalyst to
boost exposure. Emerging-markets stocks are trading at a 24
percent discount to global developed stocks based on
price-earnings value (see chart 3). Credit spreads for
high-yield debt in emerging markets are now 0.9 percent higher
than spreads for U.S. high-yield, and the spread on
investment-grade emerging-markets debt is now 0.4 percent more
than it is for U.S. triple-B-rated corporates.
For investors seeking to capitalize on the long-term growth
and dynamism of emerging markets, we believe that equities
offer the best return potential. At the same time,
emerging-markets debt also offers solid excess return potential
and can play an important role in investor allocations, given
the challenges facing developed-market sovereign debt and
In equities, investors can choose from a spectrum of
strategies. Low-volatility strategies can help investors
generate long-term outperformance by mitigating the downside in
falling markets, enabling them to stay invested over the long
term through turbulent episodes. Strategies that focus on
high-growth companies can provide powerful earnings compounding
benefits by positioning to profit from tomorrows growth
drivers while avoiding stocks and countries that were
beneficiaries of yesterdays growth. And a multiasset
approach can make active trade-offs between stocks, bonds and
currencies, generating attractive risk-adjusted returns over
time by tapping into the widest opportunity set.
No matter which approach an investor chooses, we believe
that its important to focus on high-conviction managers
who arent constrained by a benchmark. For bond investors,
the best results come when a portfolios horizons are
expanded beyond traditional benchmark limits to allow global
multisector investing across the rating spectrum and across
In equities, the MSCI emerging-markets index is dominated by
countries that are growing slower than average.
South Korea and
Taiwan two fairly mature economies together
account for more than one quarter of the total benchmark.
Benchmarks of countries including Brazil, China and Russia are
heavily skewed toward state-owned companies, which often suffer
from poor corporate governance and heavy government
intervention. We believe that moving away from the benchmark
can afford investors the opportunity to identify the most
promising holdings among thousands of diverse investment
candidates, from a Colombian bank to a South African media
group to a Chinese education company.