Brighter future for these emerging market trusts?
15th August 2016 13:25
by Lindsay Vincent from interactive investor
Past performance graphs for nearly all regional emerging market specialists have made for sorry reading in recent years.
But the managers of these three trusts believe the next few chapters in the developing markets story will be more exciting.
Blackrock Emerging Europe
If you have half your assets in Russia right now, you have a problem, no? Pose this question to Sam Vecht, manager of , and he comes over a tad testy.
"Why is it a problem? I'd suggest that having 50% of your assets in Russia is quite attractive at the moment," he retorts. "Moreover, I'd suggest the Russian economy will grow in the second half of 2016," he says, "and that this momentum will carry on into 2017."
Russia's current appeal "is not all about the economy coming out of recession. We are seeing earnings upgrades and we can buy stocks there on valuations that are among the cheapest in the world".
The rouble, which had been weak, is up 20% vs. the dollar since JanuaryVecht says there is a basic rule for investing in emerging markets, one backed up by research from, among others, the London School of Economics. First, buy into a country when its currency is cheap; secondly, "buy when GDP growth is not shooting the lights out". In other words, buy in gloom.
But fund managers cannot always have such flexibility, as illustrated by the 25% decline in the share price of Vecht's £80 million trust these past five years. The past six months have proved kinder, however, with the share price up by some 8%.
Vecht cites , the state-controlled bank that towers over all in Russia, as indicative of the "value" on offer. "Six times estimated 2017 earnings. Not unattractive."
It has a capitalisation of £31 billion, roughly the same as , pre-Brexit. Other numbers vary hugely. Sberbank's predicted net income is £4.5 billion, for instance, which is more than double that expected from Barclays.
Vecht says Russia's economy is now growing again. "In part that is because the oil price is up and also because of some of the cyclical pain that was taken as inventories were wound down.
"And the rouble, which had been weak, has begun to recover. In early January it was 82 to the dollar. Now it's 65, a 20% recovery."
The weaker currency and falling wages have made exports much more competitive - items such as defence products, industrial products and machine tools, much of which go to former USSR states, where "we are seeing a pick-up".
"Sanctions have had no economic effect," he says. Precise figures are "very difficult" to come by and, in any event, the IMF predicts GDP growth in 2017 of 1%.
Turkey, which represents some 20% of the assets of Vecht's trust, is also forecast "to have good earnings growth this year", he says.
Vecht expects 12% earnings growth in Russia next year, but the country's debts remainReturns from this volatile market have been negative for the past five years and few will be unaware of the country's exposure to refugees or the neo-Ottoman Sultan style of its president, Recep Tayyip Erdogan, in his dealings with internal and EU issues.
"The risk in Turkey is political. But how much of this priced in by the market?" Vecht asks. He was speaking ahead of the military's abortive coup in July and the market shakeout that followed.
Stocks, before this year's rout, were selling at eight or nine times earnings in January and this ratio has now fallen to between four and six times.
Vecht expects earnings growth of 12% in the country next year, but one constant is the country's debts, a problem now aggravated by ominous fallout for Europe, the Middle East and beyond.
"Turkey is beholden to foreign borrowings. If foreigners pulled the plug, banks haven't enough assets to offset that."
Vecht is not among those holding their heads at what lies ahead for Greece, the destination for some 10% of his assets. "Greece is the most interesting market in emerging Europe," he asserts.
"Labour costs are down significantly, domestic consumption is up from a very depressed level and we are seeing the early stages of a revival in domestic spending."
Aberdeen Latin American Income
Men endowed with a fondness for spaghetti and black limousines with tinted windows will certainly have respect - "rispetto" in their mother tongue - for Brazil's acting prime minister, Michel Temer.
He owes his position to the "temporary stepping down" of Dilma Rousseff following her impeachment.
The level of corruption in Brazil's parliament knows no bounds and even the interim anti-corruption minister, Fabiano Silveira, had to resign after leaked recordings of him advising a high-ranking politician on how to defend himself in the multi-billion dollar Petrobras scandal.
Temer, as joint manager Victor Szabo points out, has assembled "quite a strong economic team" to tackle Brazil's awesome difficulties that were brought on by the collapse in commodity prices and are now aggravated, in Brazil's Olympic year, by the spread of the Zika virus.
Holdings in Brazil and Mexico each make up 20% of the trust's valueBut Team Temer will have no easy path in Congress, where Rousseff still has strong support. Further, some in Congress now have Temer firmly in their sights on suspicions that his palms were also greased by no-gooders.
"It's still possible Temer will be implicated [in the corruption pit] but it will be difficult to get him. He has no email accounts and no mobile telephones. He'd be a hard man... [to nail]," he says. Cunning or simply a technophobe?
Szabo, who runs the equity side of the trust, lays it on the line. "Brazil has had two years of recession. There has been a fall in real wages and imports have collapsed. Brazil has seen nothing like this since the 1930s."
For corporate investors, he suggests, the positive from this is that falling wages and high unemployment means companies have an edge when it comes to labour costs. This at a time when inflation is hovering at around 10% and bond yields, at 16% not long ago, are 12%.
Assets of the diminutive £36 million trust are split roughly between equities and fixed interest, and Brazil, along with Mexico, each account for 20% of the fund's total value. Szabo says there is potential for both currencies to appreciate from current levels.
He also says the Mexican stockmarket, which has marked time for the past 12 months, will "start performing at some point". He explains: "The country's fundamentals are OK. If the US economy can keep up its strong growth, then Mexico is the best place [in Latin America] to benefit from that."
Latin America is probably the most volatile EM. Investors need a 5-7 year horizon In a region fraught with economic and social problems, Szabo feels it is remarkable that there has been a move to the right in countries such as Brazil, Peru and even Argentina.
"Quite amazing," he says, commenting that the opposite might reasonably have been expected. "As investors, this is good for us."
Fiona Manning, who manages the bond half of the fund, says Brazil's average 3.3% dividend yield is "good for emerging markets".
However, she explains: "Tax credits are available on debt and, to an extent, companies are reluctant to raise dividend payments. In Latin America in general, companies have prioritised investment in their businesses rather than returning money through dividends."
She adds: "In the UK, there is more of a commitment to growth in dividend payments. You don't find that dynamic in emerging markets."
The strong rally in Brazilian equities earlier this year, says Manning, reflects the more positive attitude of foreign investors to emerging markets as a whole and, in the case of Brazil, to its government.
"Some of these gains have been given back and the market is now very sensitive to news flow and short-term trading. Emerging markets are a long-term, commitment and Latin America is probably the most volatile. Investors need to consider a five to seven-year time horizon."
JP Morgan Indian Investment Trust
The Indian economy in the final quarter of 2015-16 officially grew by 7.9%, but few believe it. Rajenda Nair, co-manager of is among the doubters.
"It doesn't feel like that on the ground," he says. "We think it's growing at a slower pace, between 6 and 6.5%." Still, Nair is not downbeat. Prime minister Narendra Modi "has achieved a lot over the past two years and laid down the building blocks of a sustained recovery".
Nair doesn't fear automation in India because labour costs are so lowBut, with 25 million people entering the job market every year, in a country where one in eight is already unemployed, Nair says India needs a faster rate of growth to create jobs.
"Unemployment is a huge issue: one of India's biggest challenges for political, social and economic reasons. Everyone talks about India's demographic dividend," he says, yet it will not pay out unless there is sufficient job creation.
India's growing economy will lead naturally to widespread employment opportunities and Nair is not among those who fear the digital economy will lead to extensive use of robots, as in parts of China, where thousands of people are being replaced by machines.
In part, this is because labour costs are so low and expensive automation will not be cost-effective. Moreover, it cannot be used to build roads, railways and other infrastructure projects where cheap labour will be in high demand.
"As an equity investor, the biggest challenge is in the form of a sustainable cyclical recovery," says Nair. "The economic recovery has been delayed by the external environment and the ingredients are in place for a sustainable, two to three-year recovery."
He repeats: "Why? Because India has high inflation and high interest rates (6% and 6.75% respectively), which is diametrically opposed to the rest of the world. In the next 12-18 months, inflation and interest rates will come down and that will lead to a revival in demand."
Recent earnings growth in India but 'the rear-view mirror is dazzling'Moreover, the government is starting a new investment cycle: "Road and railways, for instance - and anaemic capital investment in the private sector will recover. We are very confident that the recovery will be sustainable."
Investors will be aware that earnings growth has barely moved the needle these past two years in India, but the rear view mirror is dazzling - especially farther down the road.
Earnings have compounded at between 12-13% over the past 20 years but, as Nair points out, "lately there has been a significant deceleration".
Nair says his trust's aim is to seek shares to own for between three and five years, or even longer. "It doesn't always work out but there are some we have held for a decade. We look for growth and that plays out over a long period."
Many regard 2016/17 as a make or break year for Modi, but Nair is unmoved. "As an institution, we take a long-term view," he says. Short term, however, Nair says he has a distinct preference for consumer stocks and that this policy has been in place since 2013.
"On the flip side we are underweight in the defensive sector and underweight IT, as this is a play on global demand. If our view is right, these positions in our portfolio will help performance."
This article was originally published by our sister magazine Money Observer here
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.