Financial crises lead to emerging market sell-offs. This time, the sell-off has been muted, as plenty of investors know the emerging markets are not to blame for the present problems. But instead of hesitating, investors should take advantage of the credit crisis to move boldly into emerging markets. Their share of the world economy is only going to grow.
Where are developed world savings to go? Most Western societies are standing at the bottom of a demographic mountain: in the next few decades, they must save a great deal more, and at decent returns, in order to provide for everyone’s old age.
For years the investment world’s problem has been how to find returns for these savings — and for all the future savings that should be made if everyone starts to be as prudent as they should.
Piling more money into domestic stocks and bonds will not substantially accelerate economic growth in the West — more likely, it will simply depress yields. So it has long been clear that at least part of the answer was to break out of those bounds and go exploring — into emerging markets and various kinds of synthetic investment.
The events of 2007 were a rockfall in the tunnel that led to the synthetic goldmine. That leaves one way out for European, North American or Japanese pension funds: emerging markets.
However, the equity and fixed income markets are quivering on the watershed. In previous times, any financial market crisis was a signal to shed risk of any kinds, including emerging market assets.
This time, investors can see that the risk is coming from the world’s most developed country — the US — and sector — the banks. Grimy Brazil, Russia and China are churning out iron ore, plastic toys and buildings just as fast as they were.
So there has not been the same exodus from emerging market assets. But still, there has been some dumping — and other funds are nervous about plunging in.
At the recent Emerging Market Trading Association winter forum in London, Michael Balboa, portfolio manager at hedge fund Millennium Global Investors, argued that although moving into emerging markets was the right thing for many pension funds to do, they might find it difficult getting a mandate to do so, when they had only recently burnt their fingers by buying another set of funky products pushed to them by investment banks — structured finance.
Yet there are arguments for pension funds and other pools of collective savings in the northern hemisphere to plunge much more deeply into emerging markets.
Jerome Booth, head of research at Ashmore Investment Management, is not a disinterested observer. Ashmore is a leading emerging markets fund manager.
But he has a point. “Globally, the big money is in the pension funds and central banks — they’re long investors and they’re undoubtedly underweight emerging markets,” he said at the same EMTA meeting. “EM will be 50% of the global market in 15 years’ time, so there is a huge technical reason to buy EM. Pension funds need to be putting 35% of their portfolios in EM today, but the allocation shift is very slow.”
An investor with no specific emerging markets axe to grind is Emanuele Ravano, co-head of European strategy at Pimco, the US bond manager owned by Allianz. “We are telling our clients they should put at least 10% of their assets in emerging markets as an average,” he told the EMTA audience. He picked out “huge opportunities” in undervalued and high yielding Asian currencies, as well as the Brazilian real.
This may even be a good time to buy. There is a strong chance of volatility in the months and years ahead, especially if economic weakness spreads out from the US. But according to Booth “leveraged investors [i.e. hedge funds] have disappeared in EM on the debt side”. With much of the hot money doused, more bargains are apparent.
For the most rampant emerging market bulls, a secular reversal is about to happen. Market participants have become used in the last 10 years to emerging markets being net exporters of capital, thanks to their export earnings and high savings rates.
But Booth believes this is an anomaly, which will reverse — indeed, may be reversed by the credit crunch.
“There are people in the markets saying ‘sell EM’ but also there are people in EM saying ‘sell the US — we thought this stuff was safe!’,” Booth says. “There is a structural shift reversing the export of savings out of the emerging markets, towards people putting more assets into emerging markets. A lot of this money is coming home.”
If he is right, Western pension fund managers would do well to get a move on — if emerging markets look overbought now, it is nothing to what they are going to be.