Emerging Market Outflows Reverse
There have been $100bn (€94bn) of outflows from emerging markets since 2012 but this trend reversed this year, which bodes well for 2017 according to East Capital, the emerging and frontier market asset manager.
Peter Elam Håkansson, chairman and chief investment officer, and Jacob Grappengiesser, partner at East Capital, said in a blog that flows are the ultimate signal investor thinking about emerging markets. They added that since the peak in 2012 there have been $100bn of outflows – in line with lower earnings per share and downgrades of gross domestic product growth but this year there was $22bn of inflows to exchange-traded funds.
“Typically passive investments including ETFs would see the first wave of inflows and active managers the second,” added East Capital. “The low liquidity in many emerging and frontier markets also means that they are more ‘sensitive’ to flows i.e. inflows might push the market up more than what would be seen in developed markets.”
Håkansson argued that many of the key supportive arguments for 2016 will also hold true for 2017 – in particular, yield, growth and value. In developed markets 29% of sovereign debt has a negative yield and they said anecdotal evidence suggests investors are getting increasingly desperate in the hunt for yield.
“Emerging and frontier markets, on the other hand, offer high real interest rates, and even higher nominal ones,” added East Capital. “A key consideration will clearly be whether investors would be willing to take local currency risk. We believe that currencies will show mixed performance during 2017, but on average they should be less volatile than in 2016.”
East Capital believes investors are likely to switch out of developed market bonds and perhaps into emerging market equities or bonds. Håkansson added that average GDP growth is also higher in emerging and frontier than developed markets, and this leads to stronger long-term sales and profit growth of companies.
“We expect this pick-up to be significant from 2017 with emerging markets’ gross domestic product growth accelerating to 4.6% from 4.2% in 2016, and if history tells us anything, emerging markets should continue the outperformance that started in 2016,” said East Capital.
Richard Turnill, global chief investment strategist at BlackRock, said in a blog that although risks to emerging assets have increased since the U.S. election due to the uncertainty of trade policies, they are outweighed by positives, including a cyclical growth pickup.
Turnill said: “Our conviction is that U.S.-led reflation – rising wages, nominal growth and inflation reinforced by an expected shift to fiscal stimulus – should be a big positive for many EM assets.” In addition greater infrastructure spending in the U.S. should boost demand for the commodities exported by emerging market producers.
BlackRock favours selected commodity producers and countries where structural reforms show a willingness to sacrifice short-term economic pain for long-term gain, such as India’s move to eliminate high cash denominations.
“Finally, we prefer hard-currency emerging market bonds—particularly high-yielding oil exporters such as Russia, Colombia and Kazakhstan—and short-duration local currency bonds in some countries,” Turnill added.
Stephen Dover, chief investment officer at Templeton Emerging Markets Group and Franklin Local Asset Management and Mark Mobius, executive chairman of Templeton Emerging Markets Group, said in a report that the change in investor sentiment towards emerging markets will provide a robust foundation for 2017.
“We believe that, while gross domestic product growth in a number of emerging-market countries has been gaining ground, it is likely that over the next few years we could see further relative advances in sizable economies like Russia and Brazil,” added Dover and Mobius.
In particular China, which has been a key concern for many observers, has shown signs of stability and remains at a strong level compared to most other large economies.
Dover and Mobius said the hunt for yield will make emerging market equities, attractive given the income prospects. “The dividend yield was an eye-catching 2.5% as of October 31, 2016, for the MSCI Emerging Markets Index,” they added.
They believe that companies in the consumer-related and information technology sectors are particularly attractive, together with Asian small-cap stocks.
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