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Is it a good time to consider returning to emerging markets?

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21 October 2015

David Prosser discusses whether now could be the time to revisit the emerging markets sector.

Emerging markets investment can be a white-knuckle ride, as anyone with money currently tied up in the world’s developing economies will know all too well right now. The shocks of the summer, including the so-called “Great Fall of China”, sent emerging markets around the globe into a spin from which they have not recovered.

Overall, the MSCI Emerging Markets Index is currently around 8.5 per cent down on its position at the end of June, but that figure masks regional variations, including some much more significant setbacks. In China itself, the market remains 19 per cent off its level at the half-year, while Brazilian equities have fallen 26 per cent. Almost every significant emerging market in the world – bar a handful of Eastern European markets – is in negative territory.

Who’d be an emerging markets investor in these circumstances? Well, potentially Numis Securities for one. The investment company analyst this week published a briefing suggesting investors and advisers consider revisiting the sector. To be clear, Numis isn’t suggesting investors pile into emerging markets en masse – but it does believe it’s possible that “the turmoil has left opportunities for investors to re-enter the sector”.

The case for doing so is twofold. First, the long-term attractions of emerging markets – their faster growth prospects, young populations, burgeoning middle classes and growing industrialisation – remain as compelling as ever. In the short-term, meanwhile, there may be a valuation opportunity.

“Historic price to earnings valuations for emerging markets are now at 11.6 times, versus an average of 13.4 times since 2004,” points out Numis. “Emerging markets valuations also look appealing relative to developed markets, trading at a 32 per cent discount on a P/E basis, versus an average of 21 per cent over the past 10 years.”

An increase in US interest rates may yet spook emerging markets further, Numis concedes, but the analyst believes investors are already expecting a rise and would take such a move as a positive sign that the US Federal Reserve has sufficient confidence in the global economic situation to risk it. In which case, emerging markets might actually get a lift.

In fact, there’s definitely an element here of Warren Buffett’s advice to be greedy when others are feeling fearful and fearful when the general sentiment is greed. It’s not necessarily that the sell-off in emerging markets has been overdone, but that current valuations may be attractive to investors looking for long-term exposure to the attractions of developing markets.

How, then, to get such exposure? Well, the 40 or so investment companies that invest in emerging markets – including global funds, regional specialists and single-country options – are a good place to start. The closed-ended structure of an investment company often proves particularly useful in markets with a tendency to volatility and rapid changes in sentiment.

Closed-end funds have an important advantage: they are never forced to sell assets in order to meet the redemption demands of investors panicked into demanding their money back. If investors do rush for the exit doors, a closed-ended fund’s share price will fall, possibly dramatically, but the fund manager isn’t forced to lock in the underlying losses on the fund’s assets in a firesale to pay off those who are departing.

This is food for thought for advisers considering a return to emerging markets. For all their undoubted attractions – and the potential right now to buy more cheaply – these markets are likely to continue to be volatile. The protection on offer from the right investment structure may prove invaluable.