- A diversified exposure across emerging markets means you are less likely to miss opportunities and don't have too much exposure to particular risks
- China has not done well recently but could improve
- While India appears expensive it has good prospects over the long term
Events across the world over the past few years, including a raft of economic problems in China, might make investors wonder whether it’s time to shift the balance of their emerging markets allocations. But investment analysts and professional investors still advocate a diversified geographic exposure, saying there are good investment opportunities across the region – as well as risks in each individual country to which it is best to avoid too much exposure.
Darius McDermott, managing director of Chelsea Financial Services, notes that the case for China is now very different to, say, 10 years ago. It has become even more authoritarian, there are concerns that debt defaults in the residential property sector could have a knock-on effect on the wider economy and the country’s relations with western nations have deteriorated in part due to fears it will invade Taiwan. However, he argues that this is 'baked into the price’ of Chinese equities.
“If you are comfortable overlooking [these] problems, Chinese equities are on very low valuations historically,” he says. “When equities are very cheap they often don’t need much of a catalyst – it is very high risk but we believe that most of concerns are in the price.”
China is also starting to ease Covid restrictions so economic growth could improve.
“If you can stomach political risk you could even consider direct exposure to China via single country fund,” says McDermott. He highlights Fidelity China Special Situations (FCSS) which was trading on an 8 per cent discount to net asset value as of 8 December, wider than its 6.4 per cent 12-month average. Alternatively, FSSA Greater China Growth’s (GB0033874321) manager, Martin Lau, has delivered strong risk-adjusted returns and outperformed in bad years for Chinese equities.
Abbas Barkhordar, manager of funds including Schroder AsiaPacific Fund (SDP), argues that “what works best is focusing on specific stocks and sectors – ones which can thrive under all scenarios – the companies [that are] most resilient” – rather than taking a top-down view on geographic allocations. He also emphasises the importance of not having all portfolio holdings pointing in one direction.
So, for example, while Schroder AsiaPacific was underweight China relative to the MSCI AC Asia ex-Japan index at the end of October, it has holdings listed in mainland China and Hong Kong which provide exposure to mainland growth. Chinese mainland “valuations are more attractive than in the past but we have concerns that they are value traps”, says Barkhordar.
He holds Hong Kong-listed property companies which tap into growing consumption – landlords who own commercial properties with shops and offices. “You get recurring revenue with landlords if they lease [the properties] to long-term tenants,” he says.
He likes Asian hardware companies such as those in the semiconductor sector. Examples include chipmakers listed in South Korea such as Samsung Electronics (KR:005930), the trust's largest holding at the end of October, and SK Hynix (KR:000660). “This is a consolidated industry so you get good returns across the cycle,” he explains.
The trust’s holdings at the end of October also included India-listed banks HDFC Bank (INDE:HDFCBANK) and ICICI Bank (INDE:ICICIBANK), and Hong Kong listed insurer AIA (HK:1299).
However, while he likes India’s growth potential, Barkhordar doesn't like the high valuations of stocks listed there. “The number of stocks which give you a valuation buffer [with safety] has diminished,” he explains.
Kunjal Gala, lead manager of Federated Hermes Global Emerging Markets Equity Fund (IE00B3DJ5K90), says that investors are now taking profits from the country, meaning next year might offer “an opportunity to buy quality stocks in India, which are correcting because people want to invest in China or Korea. From a longer term perspective, India is a very attractive place to be. The growth prospects are not going to slow down materially – India will grow sustainably at about 6 to 7 per cent [a year] and if you add inflation on top about 11 to 12 per cent [a year].”
One market which has enjoyed positive returns this year has been Latin America, and this has been reflected in the returns of funds focused on this region. There are “other emerging markets with different drivers [to China],” says McDermott. But “Brazil has gone back to its long-term average valuation while China is well below it”.
Gala adds that “Chile and Peru are very important because they supply or have access to about 40 per cent of world's copper reserves. These two countries will benefit significantly over time as demand for copper continues to rise.”
McDermott doesn’t suggest totally avoiding any emerging geographies because “it is hard to call the geopolitical” situation – rather, with risky areas you “want good valuation support. Emerging markets have been out of favour for the past 18 months. If you have no emerging markets, now could be the time to dip your toe back in, but they should not account for a big portion of your portfolio because of its risks.”
Emerging markets generally should also continue to benefit from certain long-term trends such as increasing consumer spending and, if US interest rates stop rising, a weaker US dollar.
For broad global emerging markets exposure, McDermott suggests Aubrey Global Emerging Markets Opportunities (LU1391034839), a growth focused fund which had nearly two-thirds of its assets in consumer companies at the end of November. McDermott also highlights GQG Partners Emerging Markets Equity (IE00BDGV0K75) which seeks to invest in high-quality, attractively priced companies with competitive advantages, and had over half its assets in financials and energy stocks at the end of October. The fund also had over half its assets in India and Brazil, and only 3 per cent in China, so could be a good way to diversify an emerging markets allocation that is overly focused on the world's largest economy.
