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There is more to emerging market equities

Emerging Markets

BNP Paribas Asset Management
 

Emerging market equities offer investors a wide range of diversification opportunities across economies with a solid post-pandemic growth profile that include, but also stretch beyond, China and the wider Asian region. Quang Nguyen, head of global emerging market equities, argues the case for a broad perspective and active portfolio management.

In emerging markets, much of the focus has recently gone to China and, with it, other Asian economies. China was first in and first out of the pandemic and its strong recovery from the effects of lockdowns and other epidemic-fighting constraints has been solid and has emanated to other economies in the region. Elsewhere, the performance of emerging markets has been more diverse, in part due to the initially less successful rollout of vaccines in many countries.

Before we look at regional performance, it is important to stress that the effects of the pandemic on the portfolio were limited. Early on, as the Chinese city of Wuhan went into lockdown, we were able to reduce our exposure to travel-related stocks.

With the recovery and the rollout of vaccines, some of these stocks are still trading at levels that do not fully reflect the underlying fundamentals. So, we are beginning to see opportunities there. As long-term investors, we expect many companies to benefit from the large-scale stimulus measures and supportive government policies around the world for many years ahead. That includes the obvious recovery plays, for example, the travel-related industries.

EMERGING MARKETS: MORE THAN JUST ASIA

While it is true the issues around the vaccine rollouts may have held back the performance of the overall emerging market index, it is up by 7% so far this year. On a year-on-year basis, it is up a healthy 41%. We believe it has further to go.

Before we go into the prospects, let’s now take a closer look at regional performance. Non-Asian regions such as Latin America, eastern Europe and South Africa have outperformed Asian regions so far this year. They are up by some 15% (see exhibit 1).

This underscores the fact that the emerging market complex covers a wealth of countries that should not all be tarred with the same brush and that deserve an individual assessment, both in terms of the risks, but also very much in terms of the opportunities.

DIVERSIFICATION: SEIZING THE OPPORTUNITIES

Investors should note that the broad emerging market index covers more than 25 countries and some 2 000 companies. If you are a passive investor and invest in just the index, you are effectively focusing on the top 15 companies, making up 30% of the index. That is quite a concentrated holding. We believe there is room for a broader perspective. To get the full benefit of the 1 000-odd opportunities, you need to be an active manager.

The recent rotation into value stocks has only amplified those opportunities (emerging markets are typically associated with a growth profile). We believe the growth to value/cyclical rotation will likely persist in the medium term, particularly as interest rates rise.

At a portfolio level, we have seen a rebound in commodities companies as prices rise amid the cyclical recovery of many economies and we believe they have further to go since they are still trading at a discount. Again, if you were to invest just in the index, you would miss out on such opportunities since these companies make up only a small part of the MSCI EM.

TACKLING THE RISKS: DIVERSIFICATION

It is fair to say that investing in emerging markets is often associated with geopolitical risk, but we believe the uncertainties can be navigated by means of constant diversification across countries. A further element in managing these risks is to assess each country case-by-case for issues such as capital controls, market liquidity and debt sustainability.

Since there are more than 25 countries in this complex, we believe there are plenty of opportunities to avoid countries where there is a lot of geopolitical uncertainty. Again, this means you need to manage the portfolio actively to generate alpha.

A FINAL ATTRACTION: UNDERVALUATION

Apart from diversification benefits, we believe valuations are currently attractive. The price-earnings ratio for the MSCI Emerging Markets index is at 14x. That is a discount to the MSCI World, which is at 20x, the US S&P500 at 21x and the US NASDAQ at 27x (see exhibit 2).

Emerging markets are home to some of the most innovative and largest companies in the world. So, from that perspective, the asset class is also trading at a discount to the MSCI EM’s long-term growth profile and the solid fundamentals.

This undervaluation relative to many developed markets leaves us quite optimistic about the outlook for the asset class over the next three to four years. We are focused on uncovering idiosyncratic opportunities, including attractively valued quality growth compounders, mispriced growth opportunities, and special situations as they arise.


 

This material is issued by BNP Paribas Asset Management USA, Inc. (“BNPPAM USA”)*. In Australia, BNPPAM USA is exempt from the requirement to hold an Australian financial services license under the Corporations Act 2001 in respect of the financial services. BNPPAM USA is regulated by the SEC under US laws, which differ from Australian laws. This material is distributed in Australia by BNP PARIBAS ASSET MANAGEMENT Australia Limited ABN 78 008 576 449, AFSL 223418 .

This material is produced for information purposes only for the exclusive use of wholesale clients and does not constitute:

1. an offer to buy nor a solicitation to sell, nor shall it form the basis of or be relied upon in connection with any contract or commitment whatsoever or

2. investment advice.

Opinions expressed are current as of the date appearing in this document only. This document is not to be construed as an offer to buy or sell any financial instrument. It is presented only to provide information on investment strategies and current financial market trends. The analyses and opinions contained in this document are those of BNPPAM USA, and are based upon information obtained by BNP PARIBAS ASSET MANAGEMENT USA, Inc. from sources which are believed to be reliable. BNPPAM USA provides no assurance as to the completeness or accuracy of the information contained in this document. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Investment strategies which utilize foreign exchange may entail increased risk due to political and economic uncertainties. The views expressed in this document may change at any time. Information is provided as of the date indicated and BNPPAM USA assumes no duty to update such information. There is no guarantee, either express or implied, that these investment strategies work under all market conditions. Readers should independently evaluate the information presented and reliance upon such information is at their sole discretion.

The information contained herein (and any calculation of targeted/expected returns) includes estimates and assumptions and involves significant elements of subjective judgment and analysis. No representations are made as to the accuracy of such estimates and assumptions, and there can be no assurance that actual events will not differ materially from those estimated or assumed. In the event that any of the estimates or assumptions used in this presentation prove to be untrue, results are likely to vary from those discussed herein. Past performance is not indicative of future results. The value of investments and the income derived from those investments may fluctuate over time such that the value of a portfolio at any given point in time may be more or less than its original value.

*BNP PARIBAS ASSET MANAGEMENT USA, Inc. is registered with the US Securities and Exchange Commission as an investment adviser under the Investment Advisers Act of 1940, as amended.

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