Q What were the main headwinds for emerging markets in 2022?
There has been no place to shelter wherever we look. Both emerging and developed market equities are down more than 20% year-to-date, so it has been pretty grim for equity investors. We all know what is happening with inflation and a resetting of interest rates but, specifically, four things have weighed on the emerging market equity asset class:
- Geopolitics, specifically Russia’s invasion of Ukraine, was a real wake-up call
- Policy missteps in China around overregulation of the internet and zero-COVID policy have been very tough for the market to navigate
- Extraordinarily aggressive monetary tightening, including the US [up 300 basis points (bps)], Brazil (up 1175bps), Poland (up 665bps), Hungary (up 1240bps) and Chile (up 1050bps)
- The US dollar has been spectacularly strong and that is a headwind, given that commodities are typically bought in US dollars and a lot of emerging market countries and companies have US dollar-denominated debt.
Q Looking into 2023, what do you think will signal a turning point for the asset class?
In the short term, we are cautious. Interest rates have still not peaked, and we have a global recession to navigate. But, for 2023, we are positive about the asset class. There should be significant buying opportunities at some point in the first half of 2023. For the asset class to be successful, we will need four things to apply. First, valuations have to be cheap, and valuations are now historically very cheap.
Second, the US dollar needs to have peaked, and third, the interest rate hiking cycle needs to have come to a conclusion. Fourth, developed markets must find a bottom.
I think one out of those four applies at this point, which is that emerging markets are very cheap. As we go into the first half of next year, we have got a good chance of the other three panning out and that could be a strong catalyst for a rebound in the asset class from extremely oversold levels.
Q Where do you see some of the biggest opportunities in emerging markets?
One of the things we like about the asset class - which sometimes gets lost in all of the noise - is that we actually have a lot more opportunities to invest than perhaps 10 or 20 years ago, with much higher quality companies and corporate governance improving significantly in places like Brazil and India. We also have large new areas to invest in the Middle East, which is currently booming given elevated oil prices. Elsewhere in Asia, and very recently in Asia outside China, there are plenty of opportunities for growth, at very discounted valuations.
Q How can active core exposure help dampen rotational risks and also access broader alpha opportunities?
In different market phases, different styles work. Quality is great in a bear market. It is defensive and offers some protection. While momentum style strategies work in bull markets. We think the trouble with being mono-styled is that you will work in certain parts of the cycle but not others.
We believe that plays very well to our blended style-agnostic approach, where we have elements of value, growth, and quality in our portfolios. This means there always tends to be something working for us through the cycle.
General risks. All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results. Environmental, social or governance related risk events or factors, if they occur, could cause a negative impact on the value of investments.
Specific risks. Equity investment: The value of equities (e.g. shares) and equity-related investments may vary according to company profits and future prospects as well as more general market factors. In the event of a company default (e.g. insolvency), the owners of their equity rank last in terms of any financial payment from that company. Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.