The underperformance in emerging market stocks still has some way to run, according to fund managers and analysts.
Emerging markets have underperformed their developed world peers by about 12% since the start of the year, through a combination of improving momentum in the US and Japan and increasing challenges in the BRIC economies, particularly China.
“I’ve been negative on emerging versus developed equities, especially the US, since the autumn of 2010,” said John-Paul Smith, global emerging market equity strategist at Deutsche Bank. “For me it’s a multi-year underperformance cycle and we are, at best, halfway through it.”
Maarten-Jan Bakkum, senior emerging market equity strategist at ING Investment Management, agreed. “We are now two and a half years underperforming, and it’s quite a surprise that a lot of people are still excited by emerging markets,” he said.
He identified two reasons why emerging markets would continue to “struggle”. The first was a continuing slowdown in China: he predicts a decline to 5% growth there within three to five years. The second is a lack of reform and structural change in emerging markets, certainly compared to the developed world.
Smith said a weak economic environment tended to bring out bad practices. “The corporate governance side of emerging markets is relatively cyclical,” he said. “In an economic environment which is relatively depressed, corporate governance considerations are secondary.
“We are seeing that both in the private space and in the involvement of government. You have seen several governments take actions to the detriment of minority shareholders, shifting resources away from capital towards labour and the state.” This has been most pronounced in Brazil, but there has also been evidence of it in Russia and China, he said.
Bakkum was also bearish on China. “A lot of people are counting on China growing at 8% forever. That’s strange, because growth is already at 6.6% if you annualize the first quarter.”
He said China’s demographics were unsupportive, with the labour market shrinking. Chinese growth was dependent on new credit, meaning any regulation on credit would slow growth, he added. “I have quite a high conviction call that China will have difficult times for the next three to five years.”
Both also avoid Russia. “Structurally I don’t like Russia and don’t see any reason to be invested long-term,” Bakkum said. “There is no positive change, the government is intervening in the economy more and more, and in large part it is state-owned or influenced.”
Turkey is a relative strong point in emerging markets for Bakkum. He rated it as one of three large markets on which he takes an overweight position, the others being Mexico and India.
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