By David Gait, senior analyst of global emerging markets at First State Investments According to...
By David Gait, senior analyst of global emerging markets at First State Investments
According to the latest IMF World Economic Outlook published last month, developing countries are expected to grow at 4.2% in 2002 and 5.2% in 2003, compared with 1.4% and 2.3% respectively for the major advanced economies.
Despite such growth differentials, emerging markets continue to trade at historically low valuations, both relative to developed markets and also relative to their own history.
At first glance, the contradiction between superior growth rates and low valuations can be reconciled by global investors' current anaemic appetite for risk with investors historically regarding emerging markets as being far riskier than developed markets.
Precipitous falls in developed stock markets, the revelation of endemic corporate malfeasance in Europe and America, the ongoing war on terrorism and the threat of war in Iraq have all combined to dampen enthusiasm for risky investments, whatever the potential returns.
However, there are good reasons to believe the risk profile of many emerging markets is declining. Economic mismanagement, which was once the norm rather than the exception in emerging economies, appears to be on the wane, due in part to the painful lessons learnt from crises such as the Mexican devaluation in 1994, the Asian crisis of 1997/8 and the Russian devaluation of 1998.
For example, many Asian countries have discovered in a hard way the dangers of excessive dependence on foreign debt to finance unproductive investments.
A similar story exists at the corporate level. All too often emerging market companies have failed in the past to translate growth potential into shareholder value, due to bad execution by management or poor corporate governance. Fortunately, there have been significant improvements in terms of both management execution and corporate governance over the last few years.
This has been triggered by several factors. These include the realisation that such practices seriously impact the cost of capital, the emergence of grass roots shareholder movements such as the PSPD in Korea and the better alignment of professional management, with the interests of minority shareholders through the use of stock option and share ownership schemes. Finally, with over 30 investable markets to choose from, and over 500 investable quality companies, the asset class offers a wide range of investment opportunities. In the past investors tended to treat emerging equity markets as a single homogeneous asset class.
Encouragingly there are signs that investors have become more willing to assign different risk/reward profiles to individual companies and markets, rather than to the asset class as a whole.
Current emerging markets valuations suggest investors have not yet factored in such improvements in the risk profile of emerging markets, although the relative outperformance of the asset class over recent months may encourage investors to re-examine their perception of emerging markets risk.
Superior economic growth.
Compelling valuations in emerging markets.
Risk profile steadily improving.
Poor global appetitie for risk.
Dependence on global economic change.
Corporate governance remains the norm.
Has run Cautious Managed fund since 2011
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Invested from 2006-2011