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ADVERTISING SUPPLEMENT TRENDS IN EMERGING MARKETS Cover.pdf RunDate: 04/18/16 pi supp 8 x 10.875 Color: 4/C Q: What matters most to emerging markets debt? A: Driving returns with the right risk. That’s why the Eaton Vance Emerging Markets Debt Opportunities Strategy invests broadly off-benchmark and across the spectrum of emerging and frontier market debt risk exposures. $SSURDFK,QYHVWEH\RQGWKHFRQÀQHVRI(PHUJLQJ0DUNHWLQGH[HV • Benchmark: Blended* • Target excess return: 100 – 200 bps above benchmark • Target tracking error range: 100 – 300 basis points 2XU(0IRFXVLVRQWKH´VPDOOWKLQJVµ²FRXQWU\OHYHODQGSROLWLFDOUHVHDUFKZLWK VWDQGDORQHDQDO\VLVRIVSHFLÀFULVNIDFWRUVDQDSSURDFKZHIHHOLVEHVWVXLWHGWR exploit this increasingly complex and volatile market. Partner with a pioneer We believe our bottom-up country- and risk-factor approach is the best way IRUZDUGIRU(0LQWKHQH[WGHFDGH Learn more about our approach at institutional.eatonvance.com. CASH MANAGEMENT GLOBAL MACRO SHORT DURATION MUNICIPALS CORE BOND CORE PLUS BOND MULTISECTOR FLOATING RATE HIGH YIELD EMERGING MARKET -30RUJDQ*RYHUQPHQW%RQG,QGH[(PHUJLQJ0DUNHWV*%,(0*OREDO'LYHUVLÀHG-30RUJDQ(PHUJLQJ0DUNHWV%RQG,QGH[(0%,*OREDO'LYHUVLÀHG -30RUJDQ&RUSRUDWH(PHUJLQJ0DUNHWV%RQG,QGH[&(0%,%URDG'LYHUVLÀHG 7KHUHDUHQRJXDUDQWHHVUHJDUGLQJWKHDFKLHYHPHQWRILQYHVWPHQWREMHFWLYHVWDUJHWUHWXUQVSRUWIROLRFRQVWUXFWLRQDOORFDWLRQVRUPHDVXUHPHQWV,WLVQRWSRVVLEOHWR LQYHVWGLUHFWO\LQDQLQGH[7KHYLHZVDQGVWUDWHJLHVGHVFULEHGPD\QRWEHVXLWDEOHIRUDOOLQYHVWRUV1RWDOORI(DWRQ9DQFH·VUHFRPPHQGDWLRQVKDYHEHHQRUZLOOEH SURÀWDEOH(DWRQ9DQFHGRHVQRWSURYLGHWD[RUOHJDODGYLFH3URVSHFWLYHLQYHVWRUVVKRXOGFRQVXOWZLWKDWD[RUOHJDODGYLVRUEHIRUHPDNLQJDQ\LQYHVWPHQWGHFLVLRQ ,QYHVWLQJHQWDLOVULVNVDQGWKHUHFDQEHQRDVVXUDQFHWKDW(DWRQ9DQFHDQGLWVDIÀOLDWHVZLOODFKLHYHSURÀWVRUDYRLGLQFXUULQJORVVHV (DWRQ9DQFH0DQDJHPHQW 16pi0156.pdf RunDate: 04/18/16 pi Trends supp 8 x 10.875 Color: 4/C APRIL 2016 SPONSORDIRECTORY CONTENTS VISIT www.pionline.com/trendsinemergingmarkets for exclusive featured content, white papers and information about our webinar Eaton Vance Management Two International Place Boston, MA 02110 Susan Brengle Vice President, Managing Director, Institutional 617-672-8540 [email protected] http://institutional.eatonvance.com/ Martin Currie Inc. 4 Dislocations create opportunities 1350 Avenue of the Americas Suite 3010 New York, NY 10019 Mel Bucher Executive Vice President, Head of North America 212-258-1900 [email protected] www.martincurrie.com/gems Newton Investment Management Ltd 200 Park Ave, 7th Floor New York, NY 10166 Jon Ritz 212-922-6030 [email protected] www.newtoncapitalmanagement.com Prudential Fixed Income 655 Broad Street, 8th Floor Newark, NJ 07102 Jeffrey Alt Head of North American Sales 973-367-4157 [email protected] www.prudentialfixedincome.com 8 Around the emerging markets world: Where are the opportunities today? 12 With equities, active management makes the world your oyster 13 Risks worth taking in fixed income QMA Two Gateway Center, Sixth Floor Newark, NJ 07102 Rodolfo Martell, PhD, Managing Director, Portfolio Manager and Strategist for QMA 973-367-7506 [email protected] www.qmassociates.com This special advertising supplement is not created, written or produced by the editors of Pensions & Investments and does not represent the views or opinions of the publication or its parent company, Crain Communications Inc. ADVERTISING SUPPLEMENT | TRENDS IN EMERGING MARKETS | 3 Pi Trends Pg3.pdf RunDate: 04/18/16 pi supp 8 x 10.875 Color: 4/C Dislocations create opportunities The drumbeat of bad news shouldn't scare off investors. I n 2015, the MSCI Emerging Markets Index dropped 14.46% compared with just a 0.32% decline in the MSCI World Index. As that was happening, investors pulled a record $60 billion from emerging stock and bond funds, according to fund tracker EPFR Global. In addition, the commodity super-cycle has turned negative, China’s boom appears to be winding down and political scandals continue to taint emerging market countries ranging from Brazil to Turkey to Russia. And that’s just a partial list of the challenges facing emerging markets. So why should investors consider emerging markets right now? The reasons are compelling, and hinge on a more informed understanding of these markets, as practiced by the most sophisticated money managers. “With 70% to 80% of the world’s population and the majority of global GDP, I believe it’s an asset class you have to have in your portfolio,” said Rodolfo Martell, managing director, portfolio manager and strategist at QMA. Emerging markets now make up more than 50% of global gross domestic product, according to the International Monetary Fund’s 2014 measurements that use purchasing power parity, which means, effectively, that investors ignore them at their own peril. HARD TO GENERALIZE The sheer diversity of emerging markets, which range from China to Chad, makes it hard to generalize about them. Typically, however, they tend to share “strong underlying growth driven by positive demographics and productivity changes,” said Robert Marshall-Lee, investment leader of the emerging and Asian equity team at Newton Investment Management. He also pointed to positive political changes and other reforms occurring in India, Mexico, China and the Philippines that all bode well for the long-term performance of the asset class. All that’s not to deny that many emerging market countries have had recent reversals. But the headline-grabbing bad news is already largely baked into market prices. In fact, many markets have overreacted to the headlines, which might be bad news for index investors but creates openings for active managers. “Those negative headlines have generated interesting opportunities for portfolio managers who have the resources to thoroughly investigate all of the different ways that investments can be made in EM countries,” said David Bessey, managing director and head of the emerging market debt team for Prudential Fixed Income. Given the possibilities presented by the tumult in emerging markets and their sheer diversity and size, the better question for investors is not why they should or shouldn’t ignore them, but how best to access them. Top active fund managers have answers. TURBULENT YEAR Last year was undoubtedly a turbulent year for emerging markets across the board. Surprisingly, the consensus among emerging market experts — even bullish ones — is that 2016 may not be very different. But early indications are hopeful: The MSCI EM index was up 8.30% for the month ended March 17. “The flipping of the calendar doesn’t change things. I think 2016 is going to be a bumpy year,” said Michael Cirami, a vice president at Eaton Vance Management, who focuses on emerging Europe, the Middle East and Africa. But Cirami added, “I think valuation is opening up, which is a positive.” And as he pointed out, everything has a price. The fundamentals of a country could be difficult, but if it’s sufficiently mispriced, it could create huge opportunities 4 | TRENDS IN EMERGING MARKETS | ADVERTISING SUPPLEMENT Pi Trends Pg4.pdf RunDate: 04/18/16 pi supp 8 x 10.875 Color: 4/C benchmark rate last December for the first time in nearly a for investors. Underscoring this point, Bessey observed, decade, Fed officials said in March that they would take a cau“There are countries that are fundamentally struggling from tious approach to further increases amid signs that inflation a political or economic standpoint, but there can be really was not accelerating. good opportunities to make money.” “The solutions for the challenges facing many EM counThough many investors may have a doom and gloom tries tend to be political, and to my mind that’s exactly where view of emerging market fundamentals, Cirami, who is co-dithe problem lies,” Catechis said. rector and portfolio manager with Eaton Vance’s Global InCirami agreed. “I think we need to see a better policy come Group, has a very different perspective: Given mix in EM countries,” he said, arguing that over the last few structural advantages such as low debt levels and faster popyears, emerging markets’ policy mixes by and large have been ulation growth, emerging markets are better positioned than uninspiring. He hopes for more high-profile reform stories that developed markets for the medium to long term. make it into newspapers and give investors a reason to pause “I am actually more concerned about the long-term and take notice. prospects for developed countries such as the U.S.,” Cirami said. “To see emerging markets grow faster than developed SILVER LINING will be exciting across all EM asset classes.” But there is a silver lining: In the past few months, Cirami Kim Catechis, head of global emerging markets at Marhas started to see better monetary policies and structural retin Currie, put the recent gyrations of emerging markets into forms not so much in large countries but also in a diverse perspective. group of smaller countries that often are overlooked by the fi“It took the U.K. 100 years to complete the industrial nancial news media, including Serbia, Tanzania, Albania and revolution,” he explained. “So what's happening in emerging the Republic of Georgia. markets is that they are undergoing, simultaneously, indus“What started as a trickle is turning into a stream of countrial revolutions, social, economic, political and in some cases tries that are putting together a better policy mix,” Cirami said. even cultural revolutions.” Investors, who typically make their decisions by looking He noted that for many investors, the current cyclical in the rearview mirror, were spooked by last year’s alarmdownturn seems to have overwhelmed the long-term strucing turn of events in emerging market countries tural growth story. This has created a mismatch besuch as China and Brazil, and quickly pulled tween the pessimism pervading emerging market their money out. However, a more precise sentiment and the prospects for positive longanalysis of outflows showed that not all interm growth. “Clearly whenever that happens, vestors behaved this way. Instead, the you get great opportunities for discerning inoutflows pointed to behavioral biases on vestors,” Catechis said. “Emerging market the part of retail investors. equities look appealing compared to their Percent the In the context of emerging histories, other markets and asset MSCI Emerging markets, distinguishing between retail classes.” accounts and institutional investors, who Even in the short term, economic funMarkets Index are often known as “smart money,” is imdamentals don’t support the current misdropped in portant, money managers say. match between developed and emerging 2015. “We actually have seen an increase in inmarket prices because the two groups of economies are highly interdependent. According to stitutional fixed-income allocations, despite a Marshall-Lee, “Chinese rebalancing, European QE efforts substantial reduction in the supply of new paper on and plunging commodity prices are not truly independent the market,” said Matthew C. Duda, a principal and emerging phenomena and are tightly interlinked.” market debt portfolio specialist at Prudential Fixed Income. Even if retail fixed-income investors shied away from the perSPOOKED ceived risks in emerging market countries, institutional inNonetheless, retail investors in particular seem spooked vestors found these were risks worth taking (see Risks Worth by a handful of present and looming threats to emerging marTaking in Fixed Income on page 13) in a yield-constrained kets. At the top of this list are concerns about China as it global environment. switches gears to consumer-driven demand and services and On the equity side, “the big numbers on the outflows away from commodity-dependent manufacturing. tend to be ETF and retail,” said Martin Currie’s Catechis. “We “China’s slowdown is affecting the world but it has been see institutions looking to enter or increase exposures at a very well-anticipated slowdown,” countered Martell at QMA. these lower levels,” he added. “There has been no hard landing and no panic across EM markets.” As he pointed out, whereas the emerging market CHANGE IN SENTIMENT crisis of 1997 and 1998 ensnared countries across Asia, To get those retail flows back, a major change in sentithere is no contagion today. ment about emerging markets is needed. This could be Commodity-exporting emerging market countries face sparked by positive investment returns, political reforms or an additional threat: the United States, and the rise in U.S. insome resolution to the worries about China or commodities terest rates, which can lead to weaker growth in these counthat still haunt the asset class. tries, or even debt-deflationary spirals. However, as Catechis But Catechis isn’t waiting around. explained, these countries don’t face the same pressures as “I much prefer to be finding good quality companies and in previous downturns. attractive investments for my clients at a time when a lot of “We’re not going to see those distressed valuations,” he frothy money is not there,” he explained. said. “I think the fundamentals are much stronger this time Similarly, Eaton Vance’s Cirami said, “there are outflows around.” from the asset class and so the technicals can get rough, but Moreover, there are few signs that the U.S. Federal Rewhen it gets to a level we think is cheap, and we are buying.” serve can continue to raise interest rates. After raising its Exchange-traded funds are one way to access emerging 14.46 CONTINUED ON PAGE 6 ADVERTISING SUPPLEMENT | TRENDS IN EMERGING MARKETS | 5 PI Trends Pg 5.pdf RunDate: 04/18/16 pi supp 8 x 10.875 Color: 4/C CONTINUED FROM PAGE 5 market beta, but there may be better ones. These countries are at very different stages when it comes to accounting standards, corporate governance and regulatory environments, and that can pose challenges for the blunt exchange-traded fund approach. And ETFs can’t easily tease apart all the different, gyrating cycles that impact specific assets or countries. Hence, unlike comparatively efficient developed markets, emerging market countries are a natural fit for active management (see With Equities, Active Management Makes the World Your Oyster on page 12). “To be well-positioned in EM doesn’t look anything like the index,” said Marshall-Lee at Newton. “We seek to add value and get a very different outcome.” MORE OPPORTUNITIES If anything, the index approach has created more opportunities for active stock pickers. “There are some fantastic opportunities in broad correlated sell-offs, particularly when people are shorting the index without giving any differentiation at the stock level,” he said. Leading active money managers differ in their emerging market investment processes. Some focus on the country and others on the company or sector as their key selection criteria, though both elements pay a role in any investment decision. That is, some are bottom-up country pickers whereas others are bottom-up company pickers. Each camp has its own logic. “We are 100% company-specific,” said QMA’s Martell. “We evaluate a company on its merits regardless of the country where it is domiciled.” QMA looks closely at sectors to aid in stock selection. Country exposure plays a role but it is implicit in this process, rather than the starting point. “Each company’s merits are of course to an extent going to be driven by the fortunes of the place where they are domiciled,” Martell added. By contrast, Eaton Vance looks first at the country. “We believe that country matters: It’s really the country factor that stands above all others in determining asset prices,” Cirami said, adding that forthcoming research by his colleague Marshall Stocker underscores the importance of getting the country right. Prudential Fixed Income similarly starts with a heavy emphasis on bottom-up, country-by-country analysis, using its own ratings, which can be substantially different from those of the ratings agencies. “Country analysis is an important foundation for us, but security selection is a big alpha driver too,” said Prudential’s Bessey. At Martin Currie, “we are bottom-up stock pickers,” said Catechis, head of the firm’s global emerging markets. He believes that over the long term, sectors matter more than countries, and added that there are many sources of risk. “When we think about investing in a company, we don’t just look at the numbers,” he explained. “We also look at how the management thinks about guarding against sustainability issues.” Environmental, social and governance policies are fully embedded into Martin Currie’s investment process, and team members have taken part in the United Nations’ Principles for Responsible Investment Initiative. These sorts of concerns are also very much a component of Newton’s approach. “We focus on companies and valuations,” said Marshall-Lee, who leads Newton’s Asian and emerging market equity team. Corporate governance and an assessment of potential changes to fundamentals are part of this analysis. “Within our investment universe, corporate governance and the quality of a company [are] very significant,” he said, resulting in investments in strong companies and possibilities for superior returns with lower absolute risk. Emerging markets differ from developed markets in many favorable ways, including greater possibilities for alpha. Underpinning investments in this asset class are “companies that can grow their cash flows at higher rates than are possible in the developed world,” Catechis said. Recent market dislocations have only opened up more opportunities for active management, and long-term investors “should be starting to buy and continue buying progressively over the next six to 12 months,” Marshall-Lee said. “I think it’s going to be a great opportunity.” Managers stressed that it’s important not to paint all the countries and all the individual assets within countries with the same brush. USE A DIFFERENT BRUSH What’s more, in some emerging market countries at least, clear signs of monetary policy improvements are emerging. “I think we’re starting to see more and more countries put together a better policy mix, which was a big problem for EM over the last five years,” said Eaton Vance’s Cirami. Martell at QMA suggested that given all the variation among countries, the term “emerging market” may no longer be a useful guide. “I think as a broad-based label it is probably outdated,” he said. “It was created in 1981.” Going forward, many countries now categorized as “emerging” will join the “developed” ranks, eventually overtaking and even displacing some current developed market countries. Long-term investors in emerging markets can participate in this exciting transformation. • COMPARING VOLATILITY 3 YEAR 5 YEAR 10 YEAR MSCI World 11.36 14.62 13.05 17.98 16.44 23.46 MSCI Emerging Markets Note: Annualized standard deviation based on monthly net returns data. Source: MSCI Inc. 6 | TRENDS IN EMERGING MARKETS | ADVERTISING SUPPLEMENT PI Trends Pg 6.pdf RunDate: 04/18/16 pi supp 8 x 10.875 Color: 4/C UNCOVERING OPPORTUNITIES IN EMERGING MARKETS Perception Reality FACT: ONE INDIAN COMPANY PRODUCES A FAMILY CAR EVERY 30 SECONDS… Understanding these regional and local realities means our experienced team can uncover those businesses with the potential to offer sustainable returns over the long-term. 25 years’ experience managing emerging market portfolios US$1 billion of emerging market equity assets under management Specialist team of 7 with an average of 18 years’ investment experience High active share, high-conviction, research-driven portfolios Governance and sustainability analysis helps identify the most competitive opportunities To read our latest insight on emerging markets visit: www.martincurrie.com/gems Source: Martin Currie as at 29 February 2016. The trademarks shown are that of the respective owner and are used for descriptive and illustrative purposes only. The trademarks are not in any way associated, or to be deemed to be associated, with Martin Currie or its group companies. Martin Currie Investment Management Limited, registered in Scotland (no SC066107) Martin Currie Inc, incorporated in New York and having a UK branch registered in Scotland (no SF000300), Saltire Court, 20 Castle Terrace, Edinburgh EH1 2ES Tel: (44) 131 229 5252 Fax: (44) 131 222 2532 www.martincurrie.com Both companies are authorised and regulated by the Financial Conduct Authority. Martin Currie Inc, 1350 Avenue of the Americas, Suite 3010, New York, NY 10019 is also registered with the Securities Exchange Commission. Please note that calls to the above numbers may be recorded. 16pi0153.pdf RunDate: PI Supp 04/18/16 8 x 10.875 Color: 4/C Around the emerging markets world: Where are the opportunities today? T he term “emerging markets” was introduced in 1981 by Antoine W. van Agtmael of the World Bank’s International Finance Corp. to replace the phrase “Third World” with its negative overtones. The precise definition of the term varies and is inconsistent: The International Monetary Fund puts approximately 150 countries into this category whereas the MSCI Emerging Markets Index includes only 23. However the category is defined, it is highly diverse. Here are insights into the investment prospects of specific emerging market countries today. CENTRAL AND SOUTH AMERICA Latin America, a region that underperformed in terms of fixed income in the second half of 2015, was the top performer earlier this year. “It was up about 3.3% in February alone,” said David Bessey, managing director and head of the emerging markets debt team at Prudential Fixed Income.1 Central America and South America have several standouts. “Mexico is a poster child for all the right types of reforms: energy reform, educational, fiscal, for example,” said Rodolfo Martell, managing director, portfolio and strategist manager for QMA. Argentina, with a new government and the resolution of a drawn-out court case brought by creditors over the country’s debt default, also is attracting renewed investor interest. In addition, money managers agree that interesting opportunities can be found in less closely followed countries. 8 Kim Catechis, head of global emerging markets at Martin Currie, is overweight Peru. “It has the best demographics in Latin America,” yet is underdeveloped in core services, especially financial services, where the penetration is low and use of consumer credit, especially mortgages, is in its infancy, he said. One company Catechis holds is Credicorp, a financial services firm that is well positioned to provide needed plain vanilla banking to Peruvians. The company is emblematic of the fast-growth possibilities found in countries that truly are developing. Still, Peru faces the uncertainty of an upcoming election but, according to Catechis, front-runner Keiko Fujimori’s platform is market-friendly and pragmatic. Venezuela is on or near the top of most investors’ “avoid at all costs” list but that doesn’t mean there aren’t fixed-income opportunities. “The prices on Venezuelan assets, including the national oil company, are really quite cheap even with default likely,” Bessey said. The dark cloud — a very large one — hanging over South America is Brazil. Equity investors are deeply pessimistic about the country. “Brazil basically needs to de-bottleneck politics in Brasilia,” Catechis said. The Brazilian government seems unable to rise to the economic challenges facing the country and instead is mired in political scandal. Politicians don’t “see any upside in doing the right thing, at least for the next few months and possibly most of this year,” he said. | TRENDS IN EMERGING MARKETS | ADVERTISING SUPPLEMENT PI Trends Pg 8.pdf RunDate: 04/18/16 pi supp 8 x 10.875 Color: 4/C “The right thing” Catechis is referring to is the need for “pension reform, cuts to social spending and maybe even a financial transaction tax.” But neither Brazilian President Dilma Rousseff’s political party nor the opposition want to be linked to her unpopular government, which is tainted by corruption scandals at state-run oil producer Petroleo Brasileiro SA, better known as Petrobras, and elsewhere. Given these political dynamics, Catechis said he thinks that the major reforms the country needs are unlikely to occur until a few years out at the earliest. But for fixed income, the situation is different: Brazil debt still offers an attractive yield. “Perversely, this means the politicians in Brasilia don’t feel the urgency to do anything,” Catechis said, “even though there are perfectly clear solutions for Brazil’s obvious economic challenges.” As a fixed-income investor, Prudential’s Bessey has also noticed opportunities. “Brazil just got incredibly cheap in the dollar-denominated hard currency space in particular, and so we were overweight on that country despite the fact it’s a difficult credit story,” he said. Robert Marshall-Lee, investment leader of the emerging and Asian equity team at Newton Investment Management, explained the differences between equity and fixed-income opportunities in Brazil. “I am not inclined to buy Brazil [equities] right now,” he said. As Marshall-Lee observed, the country is highly dependent on commodities and has tried but failed to keep the boom going through social handouts and an expansion of credit via state-run banks. When it comes to bonds, however, the currency and market corrections and cost of capital have resulted in very high yields. AFRICA “If we were to look at regions that underperformed in the second half of 2015, Africa would be near the top of the list, but it is an outperformer in 2016,” Bessey said. While reform-minded governments are in place in countries such as Tanzania, South Africa looms large over investor concerns. South Africa. “The country desperately needs more economic growth. Since the global financial crisis, it has probably seen its potential growth rates decline,” said Michael Cirami, a vice president at Eaton Vance Management and co-director and portfolio manager in its Global Income Group, who focuses on emerging Europe, the Middle East and Africa. South Africa has benefited for years from high commodity prices and free-flowing capital but both are now in retreat, leaving the country highly exposed. Cirami noted that the South African central bank estimates potential economic growth this year at 1.5%, well below the level needed to combat rising unemployment. Martin Currie’s Catechis has a similar take: South Africa is struggling with burgeoning population growth, a lack of jobs and a government reliant upon high commodity prices for revenue. All are real challenges with no obvious political willingness to implement solutions that involve unpopular reforms, he said. EASTERN EUROPE (Including Russia) “We’ve liked Serbia for a while but the policy mix has really gotten a lot better over the last few quarters,” Eaton Vance’s Cirami said. While he finds the investment opportunities in many large emerging market countries less than in- PI Trends Pg 9.pdf RunDate: 04/18/16 If we were to look at regions that underperformed in the second half of 2015, Africa would be near the top of the list, but it is an outperformer in 2016. David Bessey, managing director and head of the emerging market debt team at Prudential Fixed Income. spiring, that’s not true for Serbia. The government sector is shrinking or “rightsizing,” which should allow the private sector to grow. There also has been a huge uptick in foreign direct investment, he noted, a further indication that Serbia’s business environment is improving. Analysts are mixed about the prospects for investors in Hungary, in part because the country risks being further ostracized by the European Union because of its right-wing government. Cirami is not optimistic. “Hungary did a whole bunch of bad policies, such as high tax rates or going after foreign investors,” he explained. “These can work for only a little while.” In the long term, they are doomed to fail. However, Prudential Fixed Income’s Bessey argued that Hungary is likely to get a credit upgrade this year. He noted that “spreads are particularly wide in some of the quasi-sovereigns, which makes them interesting.” Dependent on commodity exporters and facing economic sanctions, Russia has little positive economic news to excite investors. “Productivity growth in Russia has been disappointing in the past 15 years,” said Marshall-Lee at Newton. But not all emerging market investors are ready to give up on Russia. “Please don’t think I'm an apologist for Putin,” Catechis said. “But the fact is Russia has, relative to many countries, a cast-iron balance sheet and a lower government gross debt level as a percentage of GDP.” He pointed out that the country has not actually collapsed under sanctions and questioned whether Europe can stomach expanding existing sanctions any further. In addition, Russia has “relatively high-caliber technocrats,” Catechis said, adding that he puts his money where his mouth is and is an investor in Russia. For his top Russian pick, see With Equities, Active Management Makes the World Your Oyster on page 12. CONTINUED ON PAGE 10 ADVERTISING SUPPLEMENT | TRENDS IN EMERGING MARKETS | 9 pi supp 8 x 10.875 Color: 4/C TrendsEmerging_Layout 1 4/12/16 8:47 AM Page 8 CONTINUED FROM PAGE 9 ASIA AND THE MIDDLE EAST (Ex-China) “There are rich pickings across Asia,” Marshall-Lee said, highlighting countries such as the Philippines that have positive demographics and ample room for productivity growth. In addition, the Philippines isn’t highly dependent on commodity exports. India is another Asian country well-positioned for growth, managers agree. “India is a great economic story, though it still has its structural challenges,” said Martell at QMA. These structural challenges manifest themselves in the microstructure of the stock market itself: It is difficult to short stocks, and so prices may overshoot. Nonetheless, he said, “India is a great asset class. Just go there with your eyes wide open.” The country also faces political and reform challenges that investors should be aware of. “Prime Minister [Narendra] Modi’s done quite a lot of things,” Martin Currie’s Catechis said, “but he’s had to resort to executive decisions, which are not really going to be the solution because they tend to have time limits on them.” Hence for him, the issues facing India are largely political. Managers are less sanguine about the outlook for countries in the Middle East. Turkey has made dramatic economic gains in the last 10 years, but “very little over the last five. Or this may be best described as nothing at all,” Cirami said. He cited domestic challenges stemming from President Recep Tayyip Erdogan’s rule as well as political unrest across the border in Syria that could spill into Turkey in various ways. “I’m concerned about the Gulf region,” Cirami said. Continued low oil prices and political instability can never be ruled out. His larger point is more of a warning: The region needs to be more on the radar of emerging market investors, or maybe all investors, given both its importance and fragility. CHINA China’s economy is decelerating. From the double-digit pace of the past several years, the country’s GDP growth is expected to slow to about 6.3% this year, according to the World Bank’s January forecast. But could this slowdown lead to an economic version of the China Syndrome, a meltdown impacting both China and emerging markets in general? Emerging market fund managers are not particularly worried. “China is making the right moves, transitioning from an investment-driven to a consumption-driven economy,” QMA’s Martell said. Similarly, a Prudential Fixed Income research note from early 2016 argued “that the current widespread and heightened concerns about ... imminent severe economic and financial dislocations in China are likely overstated.” China actually needed to slow, according to some portfolio managers, such as Newton’s Marshall-Lee. For example, there had been too much credit extended to heavy industry. Though he’s bearish about China’s overall GDP, Marshall-Lee still sees some consumer-oriented companies growing at 20% or even 40% annually. Nonetheless, there are still some wild cards investors need to be aware of. According to Cirami, the slow domestic growth could lead to a financial crisis or beggar-thy-neighbor foreign exchange policies that destabilize other emerging market countries, but that’s unlikely. “China’s slowdown is just a simple fact and that’s nothing to be concerned about,” he said. The slowdown in China was widely anticipated, even if the transition has been painful for some commodity exporters. The U.S. is not an emerging market country but has an outsized influence. And for some managers, the real concern is not the economic performance of China but rather the U.S. So why all the fear? Martell had an answer: “China is missing a good spokesman.” There is no Chinese version of European Central Bank President Mario Draghi or Federal Reserve Chairwoman Janet Yellen; instead there is a cacophony of voices about China, some informed, most not informed. What China really needs, Martell argued, “is a Mr. China or Ms. China who will go on the news and put all the country’s actions in context.” UNITED STATES The United States is not an emerging market country but it has an outsized influence on emerging markets through the dollar and global demand. And for some emerging market managers, the real concern is not the economic performance of China but rather the U.S. “I am very skeptical about the economic underpinnings of the U.S. recovery,” Marshall-Lee said. He argued that while the U.S. has been stimulated by zero interest rates that give the illusion of a recovery, in fact there has been zero productivity growth, no real wage growth, rising inequality, low labor force participation, valuations kept afloat by stock buybacks and continued economic misapplications into real estate. “None of these are signs of a truly successful economy,” he said. One implication is the dollar may be overvalued — and emerging market currencies undervalued. Marshall-Lee’s larger theme is that global trade has been buffeted not so much by conditions in China but by economic weakness in Japan, the European Union and, maybe soon, the U.S. The global economic system is highly interdependent, with economic shocks in any one of these regions rippling across emerging markets. Marshall-Lee is very concerned about the U.S. stock market in particular. “More shocks may come out of the U.S.,” he warned. • 1 Source: JP Morgan EMBI Global Diversified Latin America Sub-index 10 | TRENDS IN EMERGING MARKETS | ADVERTISING SUPPLEMENT page_10_Good.pdf RunDate: 04/18/16 pi supp 8 x 10.875 Color: 4/C We believe our global thematic investment approach is vital in helping to provide answers to our clients’ long-term challenges. For more information call Jon Ritz on 212 922 6030 or email [email protected] @NewtonIM Newton Investment Management www.newton.co.uk This is a financial promotion. This document is for institutional investors only. Your capital may be at risk. The value of investments and the income from them can fall as well as rise and investors may not get back the original amount invested. ‘Newton’ refers to the following group of affiliated companies: Newton Investment Management Limited, Newton Capital Management Limited (NCM Ltd) and Newton Capital Management LLC (NCM LLC). NCM LLC personnel are supervised persons of NCM Ltd and NCM LLC does not provide investment advice, all of which is conducted by NCM Ltd. NCM LLC and NCM Ltd are the only Newton companies to offer services in the U.S. Newton Capital Management Limited (NCM) is an investment management firm, in the UK NCM is authorized and regulated by the Financial Conduct Authority in the conduct of investment business and is a wholly owned subsidiary of The Bank of New York Mellon Corporation. Registered in England no. 2675952. Newton Capital Management Limited is registered as an investment adviser under the Investment Advisers Act of 1940. Certain information contained herein is based on outside sources believed to be reliable, but their accuracy is not guaranteed. Unless you are notified to the contrary, the products and services mentioned are not insured by the FDIC (or by any governmental entity) and are not guaranteed by or obligations of The Bank of New York or any of its affiliates. The Bank of New York assumes no responsibility for the accuracy or completeness of the above data and disclaims all expressed or implied warranties in connection therewith. © 2006 The Bank of New York Company, Inc. All rights reserved. 16pi0142.pdf RunDate: PI Supp 04/18/16 8 x 10.875 Color: 4/C With equities, active management makes the world your oyster E in Russia is in the informal sector of corner shops or even tramerging market equities are an asset class with unique charditional open-air markets. Authorities favor a transition to foracteristics — and opportunities — given that they encompass mal retailers for many reasons, including the fact that they are companies from around the world. more likely to pay tax and are more hygienic — creating op“Historically, emerging markets have behaved as a relaportunities for Magnit. tively uncorrelated asset class over a 20-year period with de“Magnit is on the right side of the authorities because veloped markets, which makes [them] attractive,” said Martin they ensure that the consumer gets good quality food, they Currie’s emerging markets head Kim Catechis. formally employ many people and they pay taxes,” Catechis Emerging market equities also tend to be highly volatile. explained. The company has strong logistics capabilities and “Historically it has had, on the equities side, volatility levoperating efficiencies that create both a competitive advanels in the magnitude of 22% to 25%,” said Rodolfo Martell of tage and a barrier to new competition. Hence his argument is QMA. “So seeing these wild changes is really business “these guys can grow and grow and grow. They’ll continue as usual for emerging markets.” to expand and go further into key cities such as Finally, the potential for alpha from security Moscow and St. Petersburg, and underprice the selection is greater in emerging markets local competition. In addition, competitors find it than developed markets given the comexpensive to go out into the provinces to compete parative efficiency of the latter. “EM eqwith Magnit.” uities are a great place to be an active Historic volatility This is even truer in other parts of Russtock picker,” said Newton Investment of emerging sia, where other retailers lack Magnit’s logistics. Management’s Robert Marshall-Lee. market equities Knowing this deeper backstory supports Catechis’ conclusion that Magnit is in the process of becoming PLAYING THE MARKET the Russian equivalent of Wal-Mart Stores Inc. in the U.S., Active management offers investors a way to with great long-term potential for investors. exploit the inherent volatility in the asset class. The one approach investors should not use with emerg“We make the most of volatility. When stocks we like drop, that gives us the opportunity to top up those names and ing market equities is to time them. take money out of those that have performed well,” said Mar“It’s not the most effective market or asset class to go shall-Lee, who is an investment leader of the emerging and play market timing,” Martell said. Compared with developed Asian equity team at Newton. Hence the short-term market markets, emerging markets are opaque, with less clarity gyrations characteristic of emerging markets equities are esaround what is driving beta than in developed markets. sentially more of an opportunity than a risk. Unfortunately, but perhaps not surprisingly, retail inMarshall-Lee might sometimes be a contrarian in the vestors mistime emerging markets. Martell’s own research, short term, but over the long term, his strategy is to invest in using data from Bloomberg, shows that realized investor returns underperformed the benchmark MSCI Emerging Marhigh-quality companies with a high return on capital underpinned by strong fundamentals in the most attractive counkets Index by an astonishing 12% in 2015 alone, due to poor tries and sectors. timing. Hence investors, rather than being spooked by short“I think the key process is keeping that long-term focus,” term volatility or negative events, should invest in emerging he said. Though future performance is never guaranteed, Marshall-Lee said, “when investing in companies, we look for the markets with a long-term buy-and-hold strategy of up to as potential to make significant upside over a five-year horizon.” much as 10 years. “Let’s just focus on three to five years, that The potential for alpha from active emerging market seshould be the time frame that EM investors should have in curity selection can be illustrated by many examples. mind,” Martell said. Take one pick of Catechis’, which is contrarian in the Easy pickings from active emerging market investing may sense that it is in Russia. He is very enthusiastic about the not be as easy as in the past when the category was less wellcountry’s largest food retailer, Magnit, which controls about known. “You have to be more nuanced,” Martell said. “But 12% of the market. By contrast, the majority of food retailing there are still rewards for those who do their homework.” • 20-25% 12 | TRENDS IN EMERGING MARKETS | ADVERTISING SUPPLEMENT PI Trends Pg 12.pdf RunDate: 04/18/16 pi supp 8 x 10.875 Color: 4/C RISKS WORTH taking in FIXED INCOME E merging market bonds carry many dimensions of risk. There's credit risk. There's currency risk. There's local rate risk. Each one has a different risk-return profile. Add political risk, and it’s easy to see why investing in emerging market fixed income is a more complex undertaking than, say, investing in domestic high yield. Still, it’s well worth the effort. “It's important to have a manager who has the resources to fully understand and investigate each of the different risks to try to identify where the best opportunities are in any individual country,” said David Bessey, managing director and head of the emerging market debt team at Prudential Fixed Income. His colleague, Matthew C. Duda, added: “EM fixed-income investing is about accruing that knowledge over credit and market cycles.” The upside of this resource-intensive process is the ability to identify well-compensated fixed-income opportunities in countries such as Brazil, South Africa or even Venezuela that normally are overlooked or even shunned by less experienced investors. Similarly, Michael Cirami, vice president at Eaton Vance Management and co-director and portfolio manager with Eaton Vance’s Global Income Group, said, “It’s important to break down EM fixedincome investing by risk factor.” His inarguable advice is that investors should buy the risk factors that are most attractive, and short or hedge out those that aren’t, to dampen volatility. Using this conceptual framework, he too has identified distinctive opportunities in emerging market fixed income right now. “Sovereign credit spreads are very, very attractive,” said Cirami, who focuses on regions including emerging Europe, the Middle East and Africa. A VAST UNIVERSE The emerging market fixed-income universe — and opportunity set — is vast, encompassing nearly 150 countries (see Around the Emerging Markets World: Where are the Opportunities Today? on page 8). Understanding individual companies and sectors within each of these countries, as well as accounting standards and CONTINUED ON PAGE 14 ADVERTISING SUPPLEMENT | TRENDS IN EMERGING MARKETS | 13 PI Trends Pg 13.pdf RunDate: 04/18/16 pi supp 8 x 10.875 Color: 4/C CONTINUED FROM PAGE 13 macroeconomic and political issues, is critical for investment success. “It’s a great asset class and it’s easy to diversify within it,” said Duda, who is principal and emerging market debt portfolio specialist at Prudential Fixed Income. This can mean diversifying across the entire group of countries, across sectors within a particular country, and also among emerging market asset classes such as sovereign debt and currencies. “You can take advantage of all these possibilities for diversification when constructing portfolios and still get a lot of spread pickup,” he added. The very richness of the emerging market fixed-income universe underscores the limitations of common benchmarks. “Benchmarks in the emerging market space are problematic for a number of reasons,” Cirami said. “The one local market benchmark that most people use only has around 15 countries.” Larger countries, which are highly exposed to global capital flows and also tend to be highly volatile, dominate these benchmarks. Given the fact that the emerging market fixed-income universe is so broad, narrowly focusing on just a benchmark can be highly restrictive when it comes to understanding the performance of emerging market managers and asset classes, and implementing an investment plan. “Tracking error hamstrings your ability to add value as a manager,” Cirami said. “There are plenty of opportunities to be in lower volatility, higher yielding countries than just those in the benchmark.” THE ROLE OF CURRENCY Currency plays an outsized role in emerging market fixedincome investing. Should investors try to harvest the risk premia associated with these currencies or hedge out this risk altogether? There is no one right answer. “I think the general view is investment managers should manage the currency exposure,” Cirami said. “Sometimes you want it. Sometimes you don’t.” He added that emerging market currencies are a risk that he generally does not want to take right now. Take Turkey as an example. Cirami finds the spreads on Turkey’s dollar-denominated bonds more attractive than those on bonds issued in Turkish lira. The local currency-denominated bond really involves two risk factors: local rates and currency. He avoids the latter risk by investing in dollar-denominated bonds. “It’s important to break down the risk factors that drive asset prices and choose the ones you want,” he said. Similarly, Prudential’s Bessey said that “when we look at local emerging markets, we make a separate decision on whether we want to be long the currency from whether we want to be long the bond.” Prudential’s emerging debt team has a similar take as Eaton Vance’s on the attractiveness of dollar-denominated emerging market bonds, though specific decisions depend on the country. In some cases, local currency-denominated bonds might look more interesting. “There might be circumstances such as last year, when we thought that South African local bonds were very, very attractive, but we actually did not like the currency, so we were long the local bonds and short the South African rand,” Bessey said. Alternatively, in Korea, Prudential’s team was more positive about the currency than the bonds. And there are other instances, such as Mexico, where Prudential was long both 14 the Mexican peso and the local corporate bond, underscoring the point that when it comes to emerging market fixed income, it is important to look at the currency and the bond as two distinct decisions. OPPORTUNITIES RIGHT NOW For Prudential’s team, dollar-denominated emerging markets fixed income is an area where they see many opportunities. Yet there are so many exceptions to this rule, such as South Africa, that it is hard to generalize. Bessey’s conclusion: “Having that very nuanced view — and taking that nuanced approach on a country-by-country basis — really is the essence of what we're trying to do with our portfolios.” For Eaton Vance’s Cirami, “We’re excited about emerging market sovereigns. Emerging market currencies, less so. We are not excited about EM corporates. Emerging market rates sit somewhere in the middle.” “There are plenty of opportunities to be in lower volatility, higher yielding countries than just those in the benchmark.” Michael Cirami, vice president, Eaton Vance Management He acknowledges that emerging markets in general have faced massive headwinds such as the commodity crisis, political scandals and credit ratings downgrades. But at the same time, emerging market dollar-denominated bonds have had total positive return performance and the sovereign balance sheets of emerging market countries now are much stronger now than they were in the past. So what’s the best emerging market fixed-income opportunity right now? “The sovereign credit asset class is more attractive than it has been since 2009,” Cirami said, “though you still have to do your homework.” • | TRENDS IN EMERGING MARKETS | ADVERTISING SUPPLEMENT PI Trends Pg 14.pdf RunDate: 04/18/16 pi supp 8 x 10.875 Color: 4/C PRUDENTIAL FIXED INCOME CAPTURE DIVERSIFIED SOURCES OF ALPHA IN EMERGING MARKETS DEBT. With long-term macroeconomic fundamentals continuing to favor emerging markets, specific challenges in key countries will almost certainly determine the winners and losers. Prudential Fixed Income has a track record with a focus on generating alpha within a rigorous top-down and bottom-up framework, applying our understanding of both country fundamentals and market factors that drive credit, currency and local bond returns. To learn more, call our North American Sales and Consultant Relations Team at 973-367-4157 or visit us at prudentialfixedincome.com EMERGING MARKET DEBT CAPABILITIES • $23 billion in emerging markets debt portfolios under management ($575 billion firm-wide)* • 20+ years of emerging markets investment experience, with nearly a decade of investing in local markets • Deep culture of disciplined risk management, quantitative research and credit research1 No risk management technique can guarantee the mitigation or elimination of risk in any market environment. © 2016 Prudential Financial, Inc. and its related entities. *As of 12/31/2015. Views and opinions are subject to change without notice. They should not be construed as investment advice. Prudential Fixed Income is a business unit of PGIM, Inc., a registered investment adviser and a Prudential Financial company. PGIM, Prudential, the Prudential logo, and the Rock symbol are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide. 2016-0869 1 16pi0144.pdf RunDate: PI Supp 04/18/16 8 x 10.875 Color: 4/C Isolating alpha with one part theory, two parts practice. At QMA, our rigorous factor analysis helps isolate alpha to deliver repeatable, scalable, consistent returns for our clients. But that’s just part of the story. At the center of our work is a team of seasoned investment professionals – with a diversity of advanced degrees, backgrounds and talents whose discipline and judgment, sharpened over market cycles, are key to our success. Their expertise drives a deeper understanding of where excess returns can be generated over time. Put QMA’s intellectual capital and systematic approach to work for your portfolio. Learn more at QMAssociates.com © 2016 QMA. All Rights Reserved. Quantitative Management Associates LLC is a business of Prudential Financial, Inc. QMA and the QMa symbol are registered service marks of Prudential Financial, Inc. and its related entities. QMA - 2015727150 16pi0155.pdf RunDate: 04/18/16 Trends pi supp 8 x 10.875 Color: 4/C