Investing during the second wave: time to buy emerging markets?

Some investors have turned bullish on emerging markets. Hannah Smith shares fund and trust ideas.

As a coronavirus second wave sweeps through Europe and the US, some parts of Asia and the emerging markets are strongly in recovery mode. For investors, could now be an opportune time to boost their exposure to some of these markets?

The outlook for Asian equities looks much brighter than the prospects for European companies, as nation states struggle to contain the virus, suggests Luca Paolini, chief strategist at Pictet Asset Management. 

“As the second wave of Covid-19 sweeps through Europe and the US, some emerging market and Asian assets look more appealing,” he says. 

However, hopes of the virus being contained in the coming months rose this week following Pfizer (NYSE:PFE) announcement of a vaccine that is “more than 90% effective in preventing Covid-19”.  

Life goes back to normal

In the meantime, Paolini’s team has downgraded European equities from overweight to neutral, and is focusing instead on better opportunities to be found in Asia, especially in China, which has been a standout performer so far this year, with its stock market up 31%.

Paolini says: “China’s economic activity has almost fully recovered to pre-pandemic levels, with strong export demand. While retail sales have lagged the strong recovery seen in other sectors, we believe there’s more room for private consumption levels to rise as the economy heads into 2021.

“We therefore retain our overweight stance on emerging-market stocks, and also upgrade Japanese equities to overweight.”

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Paolini argues that Japan is especially well placed to benefit from the recovery in Asia, with real exports growing consistently for the last four months, fiscal and monetary stimulus in place, and rising household spending. 

Andrew Hardy, co-head of research and portfolio manager at Momentum Global Investment Management, has also been adding to his positions in Japan.

“Valuations, overall, are attractive, and it is a very deep market, particularly if you can invest in a fund that can tap into smaller companies. Just like the rest of the world, it has been the growth part of the market has been firing this year, and there are a lot of great micro and small-cap growth businesses in Japan, but you can equally employ a value approach there to good effect.”

Amaya Assan, research manager at Square Mile Investment Consulting, says the fund managers she has been speaking to recently are telling her that life is back to normal for many of their Asian colleagues. In Japan, for example, children are back at school and people are taking public transport to work as they were pre-pandemic. But she notes that no one would have expected China to be such a success story so soon. “Nobody would have predicted at the beginning of the year that China, where [coronavirus] started, would be outperforming most major markets in the world.”

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Emerging-market style divergence  

Looking to emerging markets, Hardy says that he is optimistic on their prospects, especially given the latest news on a Covid-19 vaccine. While it is “not a silver bullet”, he thinks it should be a positive for risk assets in general and particularly for emerging markets, given their more cyclical nature.

Emerging markets have risen 10% year to date, although within that there is quite a stark divergence between growth and value styles, with the MSCI Emerging Markets Growth index up 26% and MSCI Emerging Markets Value down 5%, says Assan. “If people want to invest in emerging markets, I would recommend holding a range of funds with different styles. It is dangerous to hold strategies that are like boats only sailing in one direction,” she adds.

What about fixed income?

Emerging markets are not just a stock-market story. Hardy accesses the theme through a mix of Asian and emerging-market equities, emerging-market corporate bonds, and Asian convertible bonds. 

Paolini is currently seeing compelling yields on Chinese government bonds, with the 10-year bond currently offering a record spread above US Treasuries. “As the global mountain of negative-yielding debt grows, the attractions of local currency Chinese bonds come into view. This $14 trillion (£10.8 trillion) market, the world’s second largest, has seen record inflows in the first eight months of the year alone, thanks to such bonds’ attractive yield, low volatility and diversification benefits,” he says. 

“We continue to express our preference for Chinese onshore bonds with an overweight stance in emerging local currency debt.”

Fund and trust ideas

Which funds and investment trusts could investors consider if they are wanting to add emerging-market or Asian exposure to their portfolios? Hardy likes Prusik Asian Equity Income managed by Tom Naughton, who he describes as an excellent stock picker. “He’s had a torrid time performance-wise over the last year or two because his style of investing has been somewhat out of favour,” Hardy explains, noting that the large tech names that have outperformed don’t fit into Naughton’s value-oriented approach. 

The fund, however, has a healthy 6% dividend yield, so he is happy to be paid to wait for performance to turn around.

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In the investment trust space, Hardy points to the Pacific Assets (LSE:PAC) trust, which has struggled for some time owing to a low allocation to China and a high weighting to India. However, it has a portfolio of good-quality businesses and the discount of around 10% to 12% is an added bonus, says Hardy. 

In the fixed-income space, he likes Jupiter Global Emerging Market Short Duration Corporate Bond, which has an experienced team and is broadly diversified across emerging-market credit. 

Assan favours the Goldman Sachs Emerging Markets Equity fund which, with 100 to 150 stocks, is more diversified than other funds that tend to be more concentrated than a standard index, she notes. She also highlights Lazard Emerging Markets, a fund with a value investing bias run by a seasoned investor who is well supported by a wider team. 

An option for China exposure is First Sentier Greater China Growth, which focuses on quality growth and rigorous stock selection without sticking closely to the index.