Asset manager Schroders has predicted a challenging year for emerging markets in 2014, with good fundamental reasons to invest but clouds on the horizon.
Emerging market equities have underperformed developed markets for the last three years, according to Schroders’ head of of EM equities, Allan Conway. But he said fundamentals remained very solid, with many EM countries having good balance sheets. “This is in stark contrast to the developed world which is still going through a prolonged period of debt deleveraging,” he commented. Conway added that an expanding EM middle class continued to drive strong consumption, and fixed capital investment is growing due to the still low levels of capital stock per capita. In addition, Conway said that valuations are very attractive and bad news appeared to be priced in, with valuations at a discount to their long-term averages.
But the expected normalisation of US macro-economic policies is a cloud on the horizon for emerging markets and could hit countries with large current account deficits, such as Brazil, India, South Africa, Indonesia and Turkey – the so-called “fragile five”. This made the choice of countries very important for emerging market equity investors, Conway said.
On emerging market debt, Schroders’ head of EMD, James Barrineau commented: “Emerging market debt will finish 2013 in negative territory, a victim of US Treasury volatility spurred by potential changes in US Federal Reserve (Fed) policy. The most liquid parts of the asset class – sovereign dollar bonds – have fared the worst given their correlation to treasuries.” Barrineau said a new approach to EM debt investing is needed, in view of the likely repricing of 10-year US Treasuries at around 3.25% to 3.5%. “We think exposure to the widest possible opportunity set in emerging markets is the best way to avoid this risk, and gives the highest probability of achieving attractive absolute returns.”