Opinion | Bear vs Bull Clashes in EM

Chris Elsmark and Jens Bjorheim | April 7, 2020

We live in a peculiar investment environment in which weaknesses in underlying economic prospects and societal values coincides with the human tragedy of COVID-19, oil price wars and zero interest rates. Markets are in a dis-equilibrium, with uncertainty rooted in the efficacy of macroeconomic policymakers and the resilience of production chains and financial systems. Emerging Market (EM) equities have not been immune to the recent rapid de-risking and extreme volatility experienced in global financial markets. The scale of US dollar outflows from the emerging world has been significant. In addition, for structural reasons, the human cost on the world’s poorer populations could be pronounced. In this note, we reflect on what lies ahead for global emerging markets equity investors.

Our recent conversations with asset owners in the EMEA region suggest there is somewhat less conviction that now is the time to add significant exposure to EM equities. There is an expectation that better entry points may lie ahead. While short-term market movements will be futile to predict, many investors are proceeding with caution as nobody knows the unintended consequences of actions taken today. This feedback we obtained is also reflected in a recent Institutional Investor’s Allocator Intel report that gathered data from over 100 asset owners in Europe during 25th-28th March. When asked, “what do you see as the most attractive risk-adjusted public market buying opportunities in this current market environment?”, 40% answered it was too early to tell. Interestingly, of the remaining answers, the four (highest mentioned) assets classes were as follows: 

• Developed Market Equities (34%)
• High Yield (23%)
• Corporate Fixed Income (17%)
• EM Equities (16%)

Amid the current market volatility, prudent asset managers have stressed tested investments to ensure their portfolios can weather these uncharted waters. Undoubtedly, there are companies that have ended up with more operational risk in this current environment; they no longer provide the necessary downside protection that some portfolios/investors might want. It is no surprise that asset-intensive, cyclical businesses (particularly those exposed to travel and tourism) would fall within this area.  

But not all is doom and gloom for beneath the waves there are opportunities to selectively build and reinforce EM equity portfolios by investing in 1) quality businesses with higher earnings visibility and who are trading at a discount (for instance, Chinese domestic consumption oriented businesses) and 2) well-established businesses where the “worst case scenario” seems to be already priced in (for instance, where the market’s expectations are far too pessimistic). 

That is not to say there won’t be risks. Limiting (or having no) exposure to countries that might experience increased stress in the real economy and have adverse currency movements against the US dollar sounds sensible. As the Chinese government is cautiously reopening economic activity, investors might feel more confident to take advantage of investment opportunities there as they arise. In the short term, however, there is a risk that active EM equity managers might crowd back into a common basket of names. In an unpredictable world, maintaining a more balanced style exposure and positive differentiation in underlying stock holdings might be preferred for long-term investors.

For informational purposes only. For professional investors, not for retail. The views expressed in this article are solely those of the authors and do not necessarily reflect the views or opinions of their employers. While the information contained herein is believed to be reliable, there is no guarantee to the accuracy or completeness of any statement in this discussion. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. This article may be subject to change, revision, and rethinking. As of April 7th, 2020.