The manager of the Oakmark International Fund, David Herro, believes it is a good time to invest in emerging markets. The fund had roughly one-quarter of its portfolio in emerging markets in the late 1990s and “benefited greatly” from that decision over the next decade, Herro says. Then, investors became interested in emerging market stocks and “by the end of the last decade, prices got stretched,” so the fund reduced its emerging market stocks to near zero. “Now we’re finally starting to see that come full circle again,” according to Herro. He points to both “good valuations” of companies and a “tailwind” from undervalued currencies in countries like Indonesia.
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Emerging markets (EM) are undergoing long-term shifts that are not favorable to EM equities, according to managers of EM funds. “Things have changed,” says the executive chairman of Franklin Templeton’s emerging-markets group, Mark Mobius. The more than 20% decline in such stocks does not make them a value, based on marcoeconomic indicators. Average expansion in EMs has fallen to below 5% (down from 8% in 2007), placing them just 2.5 percentage points above developed countries (the smallest difference since 2002).
Improvement in equities is not on the horizon. “We’re looking for a long, drawn-out period of subdued economic growth,” says Rashique Rahman, head of EM fixed income at Invesco. EM exports have also stopped growing, due to reduced demand resulting from the Chinese slowdown and subpar recovery in the U.S. and Europe. A report by the Bank of International Settlements identified a half-dozen big EMs with credit-to-GDP ratios associated with “serious banking strains.” EM governments and companies did not, by and large, prepare for slowdown. Chuck Knudsen, EM equity strategist with T. Rowe Price, says that average return on equity and capital has declined for each of the past four years.
There may be niches of value in EM equities. Knudsen points to insurance and food retail; Todd McClone, co-manager of the William Blair Emerging Markets Small Cap Growth fund, identifies pollution-control and alternative energy in China and mortgage lenders and private hospitals in India.
Fixed-income investment in EMs may fare better. Most EM governments appear to have learned fiscal discipline since the last major crisis nearly 20 years ago. Rahman of Invesco notes, “[o]ur base-case scenario is no sovereign defaults among mainstream countries.”
Mohamed El-Erian says we are seeing a “classic overshoot” to the downside in emerging markets right now, which should lead to more pain in the near term but opportunity over the longer term.
Fundamental indexing guru Rob Arnott says that to get bargains, you have to invest in places where fears are high. Right now, he says that means to look in places like emerging markets and Europe.
Top fund manager David Herro thinks emerging-market stocks remain overpriced, but he thinks there is a way for investors to benefit from emerging market growth.
Justin Leverenz, whose developing market fund is one of the best performers in its class over the past five and ten years, says he thinks a number of inaccurate views are leading investors to stay away from emerging markets.
David Herro has been one of the top fund managers in the world for over a decade, and he says emerging markets are looking overvalued even after recent declines.