10 May 2016

Time to reconsider Emerging Markets?

After a prolonged period of doom and gloom, the news emanating from Emerging Markets has taken on a more positive tone since the start of 2016. Encouraging macro-economic reports out of China, including both trade data for March and first quarter GDP growth that matched expectations at 6.7%, have allayed immediate fears of a ‘hard (economic) landing’ in the Emerging Markets’ key driver.

This in turn has created a more favourable environment for commodities, with prices rebounding sharply off recent lows and particularly helping those markets with more exposure to Materials stocks. Even Brazil, in the midst of impeachment proceedings against its president and one of the worst performing markets in 2015, has staged a sharp rebound.

Indeed, the first quarter of 2016 saw the MSCI Emerging Markets’ Index outperform its Developed Markets’ counterpart by the biggest margin (with both reporting in US dollars) since the second quarter of 2009. While absolute returns are still muted (especially when reported in Australian dollar terms given its recent strength), the relative outperformance is interesting, particularly given that Emerging Markets have underperformed Developed Markets by over 12% pa in the 5 years to the end of December 2015.

This prolonged period of Emerging Market underperformance to the end of December 2015 has led to a sharp divergence in valuations when compared to Developed Markets. Developed Markets in the US and Europe are trading well above their 10-year average levels (using Price-to-Earnings), though Emerging Markets are at or below their longer term averages. In fact, relative to Developed Markets, Emerging Markets are trading at close to the cheapest levels seen in the last decade.

However, even though recent macro-economic data is less adverse and the relative valuation argument is starting to look attractive, investors in general remain cautious about Emerging Markets.

What is causing this reticence in the short-term? While the immediate threat of a ‘hard landing’ may have receded, China’s economic growth rate still continues to slow. And while the transition in China towards a more sustainable and balanced economy looks promising, that journey may be bumpy and not without its challenges.

The other conundrum that weighed on Emerging Markets’ performance more broadly in 2015 was a strengthening of the US dollar. As well as raising the cost of US dollar denominated debt for Emerging Market corporates, the prospect of a series of interest rate rises in the US was also prompting capital outflow from the region. However, since the start of 2016, the US Federal Reserve has talked a more cautious approach towards raising rates, which has seen the risk of a stronger US dollar abate for now.

This has made the decision for new investors into the region challenging. While the medium term growth potential from Emerging Markets remains attractive and while the current valuations, especially relative to Developed Markets, are appealing, was the performance in the first quarter merely a false dawn? An important consideration remains around the inherent volatility in the asset class, and the preference for a reasonably clear investment horizon. The problem, of course, with trying to time any market is that it is incredibly difficult.

One solution for the long-term investor is to identify a manager that can participate in the growth potential while at the same time helping to mitigate that inherent volatility. One such strategy is through investing in emerging market stocks that offer both capital growth potential as well as higher than average dividend yields.

Zurich Investments Emerging Markets Equity Fund pursues this strategy and is aimed at long-term investors seeking to participate in emerging markets’ growth through a disciplined investment process that can reduce the effects of stock market volatility.

Dividend yield has been an important component of total return in emerging markets over the last 20 years and also introduces some defensive characteristics into a portfolio. This can reduce the need to time the market and makes the strategy an attractive long-term proposition.

Perhaps surprising to some, dividends are widely available across all sectors within Emerging Markets, with 89% of companies within the Emerging Markets Index paying a dividend. The table below shows the percentage of each sector’s market capitalization that pays a dividend.

MArket Cap

For more information regarding the recent performance of Zurich’s broad suite of managed funds, please contact the Zurich Investments Sales Team on 1800 004 480 or zurich.investments@zurich.com.au

Important information: The content of this publication are the opinions of the writer and is intended as general information only which does not take into account the personal investment objectives, financial situation or needs of any person. It is dated 20th April 2016, is given in good faith and is derived from sources believed to be accurate as at this date, which may be subject to change. It should not be considered to be a comprehensive statement on any matter and should not be relied on as such. Neither Zurich Australia Limited ABN 92 000 010 195 AFSL 232510, nor Zurich Investment Management Limited ABN 56 063 278 400 AFSL 232511 of 5 Blue Street North Sydney NSW 2060, nor any of its related entities, employees or directors (Zurich) give any warranty of reliability or accuracy nor accept any responsibility arising in any way including by reason of negligence for errors and omissions. Zurich recommends investors seek advice from appropriately qualified financial advisers. Zurich and its related entities receive remuneration such as fees, charges and premiums for the financial products which they issue. Details of these payments can be found in the relevant fund Product Disclosure Statement. No part of this document may be reproduced without prior written permission from Zurich.
Past performance is not reliable indicator of future performance. GINN FVHHKJ.00012.ME.036.
CSTT – 011312-2016

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