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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.
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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
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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
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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
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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
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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.
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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.
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“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-
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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.
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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
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is vital in helping to provide answers to our clients’
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or email [email protected]
@NewtonIM
Newton Investment Management
www.newton.co.uk
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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
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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
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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
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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
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with one part theory,
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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
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Learn more at QMAssociates.com
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