Emerging Markets: Still a Buy or a Missed Opportunity?

Brian Wolahan

Senior Vice President, Senior Portfolio Manager

September 2016

Our March 2016 Perspectives, "Emerging Market Equities – Where to Now?" reviewed the state of emerging market equities following their rally earlier in the year. Our expectation then was that emerging equities were likely to return 7% annually over the next five years, nearly 2% above developed market equities, driven primarily by a reversion of valuations. From April through August, emerging stocks indeed outperformed, returning 8.6% versus 5.7% for MSCI World. The question now is whether emerging equities still warrant investor attention, or has the opportunity passed?

Let’s start by placing the recent emerging equity rally into a slightly longer-term context: MSCI EM returned 14.8% from January through August 2016—but it had lost nearly 15% in 2015. So on a cumulative basis, emerging stocks are still trading about 2% below their January 2015 prices. In comparison, MSCI World developed market equities have gained 5% since the beginning of 2015. This extends a pattern of emerging equity underperformance since the global financial crisis in 2008.   

As a result of this poor relative performance, emerging equities are trading at a considerable discount versus developed markets. Table 1 shows that the MSCI World index looks rich when comparing a selection of current value metrics to 10-year trailing averages. But for MSCI EM, earnings-based premiums are more modest, and Price/Book actually is 17% below its 10-year average. What’s more, the rightmost two columns show that current EM-to-DM valuation discounts of 32%, 31%, and 26% on Price/Book, Price/Earnings, and Price/Cash Earnings, respectively, are below their 10-year averages. So although emerging markets may not look cheap based on all multiples relative to their own historical levels, they seem a bargain when compared to the developed world.

What might this relative valuation discount imply for our expectations of returns going forward? As outlined in our March Perspectives, we can estimate future long-term equity returns based on forecasted changes in valuations, earnings growth, and dividend yields. Table 2 shows 5-year return forecasts for DM and EM equities based on a range of period-ending P/E multiples and earnings growth rates and an assumption of stable dividend yields.

Table 1

table 1 
Source: MSCI Emerging Markets, MSCI World, Acadian. For illustrative purposes only. Past performance is no guarantee of future results. Investors have the opportunity for loss as well as profits. It is not possible to invest directly in any index. Index source: MSCI. Copyright MSCI 2016. All Rights Reserved. Unpublished. PROPRIETARY TO MSCI. MSCI World, Emerging Markets indices. Copyright MSCI 2016. All Rights Reserved. Unpublished. PROPRIETARY TO MSCI. Return data is in U.S. dollars and includes gross dividends; date range: 4/1/2016 – 8/31/2016.

We’ve highlighted cells reflecting assumptions 1) that each equity class reverts to its own 10-year historic valuation, and 2) 4% nominal earnings growth in both DM and EM. The resulting forecasts of 2.6% annualized for DM and 5.3% for EM compare unfavorably to March projections of 5.1% and 7.0%, respectively, reflecting rallies in both equity classes without commensurate increases in underlying earnings. But because developed equities have become comparatively more expensive, the EM-over-DM expected returns spread has actually widened to 2.7% from 1.9%. 

In selecting stocks for actively managed EM portfolios, average valuations aren’t all that matter—we care about breadth of the opportunity set. To that end, Figure 1 shows that cross-sectional standard deviations of P/B ratios in MSCI EM and MSCI World are roughly as high as they have been over the past decade. This is especially promising for EM, given that its average P/B multiple doesn’t look historically high. So on the basis of P/B, the asset class looks attractive in aggregate, and so do opportunities for active management.

Table 2

table 2 
Source: MSCI Emerging Markets, MSCI World, Acadian. Returns are calculated using a proprietary methodology based on the concepts introduced in: Bogle, John C., “Investing in the 1990s,” Journal of Portfolio Management, Vol. 17, No. 3, (Spring 1991): 5-14. For illustrative purposes only. Past performance is no guarantee of future results. Investors have the opportunity for loss as well as profits. It is not possible to invest directly in any index. Index Source: MSCI. Copyright MSCI 2016. All Rights Reserved. Unpublished. PROPRIETARY TO MSCI.

Figure 1

figure 1 
* P/B ratios calculated semi-annually. Cross-sectional standard deviations calculated among MSCI World and EM constituents excluding P/B ratios above 15 (98th percentile) and below 0. Source: MSCI World, Emerging Markets indices. Copyright MSCI 2016. All Rights Reserved. Unpublished. PROPRIETARY TO MSCI. For illustrative purposes only. Past performance is no guarantee of future results. Investors have the opportunity for loss as well as profits. It is not possible to invest directly in any index.

How has the risk environment changed since we published the original piece at the end of March? Revisiting a few aspects that we touched on then: 

  • Growth Forecasts: The IMF’s July 2016 update of its World Economic Outlook left growth forecasts for EM unchanged vs. April at 4.1% for 2016 and 4.6% for 2017. For advanced economies, growth forecasts were reduced to 1.8% for both years, however, reflecting Brexit as a threat to European GDP. 
  • Commodity Prices: Commodities have generally remained above the lows many experienced early in 2016. Copper, oil, and gold as examples are all above their January levels and the latter two above their March prices – albeit with some recent volatility. For particular emerging countries dependent on extractive industries, those rebounds might pose increased downside risk. But we’d reiterate that contrary to conventional wisdom, emerging equities in aggregate are only modestly more heavily weighted in energy and materials companies than the World index. As of August 31, 13.7% of MSCI EM represented energy and materials companies versus 11.4% for MSCI World. 
  • Interest Rates: While there is a fairly widespread perception that emerging equities broadly share negative exposure to global interest rates, we see heterogeneity in sensitivities. The possibility of rate increases does pose a threat to some emerging countries, such as Brazil and Turkey, but key markets including China, South Korea, and Taiwan, which total over 50% of the MSCI EM index, enjoy current account surpluses. As well, despite recent speculation about acceleration of U.S. rate hikes, on balance we believe that global interest rates will remain accommodative for the foreseeable future. Furthermore, if the basis for material rate increases were a substantial improvement in the growth outlook, the net effect for equities globally might be positive.
  • China: The second largest economy globally and the largest market in the MSCI EM index at 27%, China has significant influence on developing and advanced economies. For example, it is the largest export destination for South Korea and Taiwan, so its growth has an impact on many key emerging economies. The latest IMF growth forecasts for China are 6.7% for 2016 and 6.2% for 2017, modestly above their growth forecasts in April and still significantly above expectation for emerging and advanced markets in aggregate. 

Conclusion

Our return forecasts for emerging equities have come down since our March Perspectives, but they remain significantly above those of developed markets. And although market crises by nature are challenging to predict, most of the more obvious risks to emerging equities don’t appear especially heightened in the near term and/or are largely not unique to these markets. In an environment of diminished returns expectations for most asset classes, we believe emerging equities currently represent one of the more appealing options to global investors.

For institutional investor use only. Not to be reproduced or disseminated. For illustrative purposes only. This should not be considered a recommendation to buy or sell any specific security.

General Legal Disclaimer

Acadian provides this material as a general overview of the firm, our processes and our investment capabilities. It has been provided for informational purposes only. It does not constitute or form part of any offer to issue or sell, or any solicitation of any offer to subscribe or to purchase, shares, units or other interests in investments that may be referred to herein and must not be construed as investment or financial product advice. Acadian has not considered any reader’s financial situation, objective or needs in providing the relevant information.


The value of investments may fall as well as rise and you may not get back your original investment. Past performance is not necessarily a guide to future performance or returns. Acadian has taken all reasonable care to ensure that the information contained in this material is accurate at the time of its distribution, no representation or warranty, express or implied, is made as to the accuracy, reliability or completeness of such information.

This material contains privileged and confidential information and is intended only for the recipient/s. Any distribution, reproduction or other use of this presentation by recipients is strictly prohibited. If you are not the intended recipient and this presentation has been sent or passed on to you in error, please contact us immediately. Confidentiality and privilege are not lost by this presentation having been sent or passed on to you in error.


Acadian’s quantitative investment process is supported by extensive proprietary computer code. Acadian’s researchers, software developers, and IT teams follow a structured design, development, testing, change control, and review processes during the development of its systems and the implementation within our investment process. These controls and their effectiveness are subject to regular internal reviews, at least annual independent review by our SOC1 auditor. However, despite these extensive controls it is possible that errors may occur in coding and within the investment process, as is the case with any complex software or data-driven model, and no guarantee or warranty can be provided that any quantitative investment model is completely free of errors. Any such errors could have a negative impact on investment results. We have in place control systems and processes which are intended to identify in a timely manner any such errors which would have a material impact on the investment process.


Acadian Asset Management LLC has wholly owned affiliates located in London, Singapore, Sydney, and Tokyo. Pursuant to the terms of service level agreements with each affiliate, employees of Acadian Asset Management LLC may provide certain services on behalf of each affiliate and employees of each affiliate may provide certain administrative services, including marketing and client service, on behalf of Acadian Asset Management LLC.


Acadian Asset Management LLC is registered as an investment adviser with the U.S. Securities and Exchange Commission. Registration of an investment adviser does not imply any level of skill or training.


Acadian Asset Management (Japan) is a Financial Instrument Operator (Discretionary Investment Management Business). Register Number Director General Kanto Local Financial Bureau (Kinsho) Number 2814. Member of Japan Investment Advisers Association.


Acadian Asset Management (Singapore) Pte Ltd, (Registration Number: 199902125D) is licensed by the Monetary Authority of Singapore.


Acadian Asset Management (Australia) Limited (ABN 41 114 200 127) is the holder of Australian financial services license number 291872 (“AFSL”). Under the terms of its AFSL, Acadian Asset Management (Australia) Limited is limited to providing the financial services under its license to wholesale clients only. This marketing material is not to be provided to retail clients.

Acadian Asset Management (UK) Limited is authorized and regulated by the Financial Conduct Authority (‘the FCA’) and is a limited liability company incorporated in England and Wales with company number 05644066. Acadian Asset Management (UK) Limited will only make this material available to Professional Clients and Eligible Counterparties as defined by the FCA under the Markets in Financial Instruments Directive.

Back To Top