With the US economy cooling and interest rates approaching a likely peak, a new cycle in emerging markets is drawing near. How should investors approach it? In a new paper, Portfolio Manager Mike Hugman offers this suggestion: abandon your preconceptions. That’s because the next cycle is likely to differ from any that have gone before.
We believe that after a long period of rebalancing, valuations of EM assets look attractive
Past performance is not a reliable indicator of future results, losses may be made.
Source: Investec AM, JP Morgan, 31 Dec 2018. Chart shows local debt (JP Morgan GBI-EM Global Diversified index; rolling 3-year returns, annualised).
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The paper takes a deep dive into the previous two economic cycles in emerging markets and considers what lessons they hold for investors:
- Stellar cycle (2003 to 2012): emerging markets produced very impressive returns, with local and hard currency debt returning about 12% and 11% p.a., respectively. But don’t expect repeat performance. For one thing, China’s modernisation programme, which drove a commodity supercycle, was a once-in-a-generation event. For another, EM assets were unusually cheap back in 2003.
- Lacklustre cycle (2013 to 2018): local debt declined by 2.3% p.a., and hard currency debt returned a disappointing 3.1% p.a. But investors shouldn’t let this weak performance cloud their judgment, the paper argues. One reason this cycle’s returns look so meagre is that valuations were stretched at the start. Another key reason for optimism is that the ‘lacklustre cycle’ saw both the public and private sectors in emerging markets undergo long and painful structural transformations. These have left the developing world stronger, more resilient to outside shocks, and with the potential to deliver solid investment returns, particularly on a relative basis.
We believe that after a long period of rebalancing, valuations of emerging market assets look attractive. For investors with an understanding of the risks, an appropriate time horizon and realistic expectations, we regard this as an attractive entry point and a good time to reassess existing allocations.
As it says on nearly every investment publication, ‘past performance is no guide to the future’. Investors whose views on emerging markets are anchored in either of the last two cycles would do well to pay particular attention to those words as a new economic regime approaches.
The value of investments, and any income generated from them, can fall as well as rise.
Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.
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All rights reserved. Issued by Investec Asset Management, issued February 2019.
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