EM equity fund flows disappoint GSAM

This is despite the strong performance of several EM stock markets this year, as Goldman Sachs's ‘Next 11’ index shows.
EM equity fund flows disappoint GSAM

Flows into emerging market equities, including Asian stocks, have not reflected the strong performance of certain EM stock markets this year, says Katie Koch, senior portfolio manager of Goldman Sachs Asset Management. But that means it’s a good time to get in, she stresses.

“[EM equity flows] haven’t picked up as much as we thought they would,” notes London-based Koch, who is also chief of staff to GSAM chairman Jim O’Neill.

Just $11 billion net has been invested in EM equity funds globally this year to the end of July, falling well short of recouping the $50 billion in outflows in 2011.

“Valuations tell you it’s actually a very good time to be putting money to work in emerging markets, and Asia specifically,” suggests Koch. “But it’s been hard to convince investors to do it, because all the other [macro] risks are keeping appetite low.”

As disappointing as the Bric countries’ equity performance has been in the past 18 months, she notes, the ‘Next 11’ index is 15% up year-to-date as at the end of July.

The N-11 is a grouping devised by Goldman Sachs that includes what it categorises as four large ‘growth markets’ (Indonesia, Mexico, South Korea and Turkey) as well as Bangladesh, Egypt, Iran, Nigeria, Pakistan, the Philippines and Vietnam. The fund house takes the view that the growth markets’ economies are too big and advanced to be labelled EMs any longer.

Koch points to the diversification inherent in the N-11 index, not only by geography, but also stage of development and sector exposure. Another plus point this year is that these countries between them have little exposure to the commodities market (15% of stocks are commodities-related).

Most of them are oil importers, for example, and have thus benefited from crude prices retrenching in 2012. The bulk of the Next 11 exposure is to domestic consumer markets.

Another decent equity performer this year is India, with the MSCI India index up 6% as of end-July following a fall of 37% in 2011. That’s partly because it is also an importer of oil, says Koch, but also because investors feel that the government has made a lot of progress on the recent telecoms scandal and is taking it seriously.

(The scandal blew up around the 2008 sale of telecom licences to eight companies, including six with foreign stakeholders, of which all eight are due to have their permits revoked.)

“There is also some optimism that some of the political gridlock will ease,” adds Koch, pointing to the backlog in decision-making in the past year on the back of corruption concerns and political wrangling. “And finally, India hasn’t been the most friendly company for FDI [foreign direct investment], but some of the sentiment around that is changing."

Asked how concerned she is about the slowdown in China, Koch sounds sanguine. Economic growth has slowed because the government has applied the policy brakes with that aim, she points out, so they should be able to re-inflate the economy if they need to.

And, in any case, China will grow slower in the coming decade than the last one, notes Koch, but it will be higher-quality, more internally generated growth.

That will mean better equity opportunities both inside China, especially given that the A- and H-share markets are trading at a “very cheap” 10x price/earnings – and outside it in markets with exposure to the country. 

Moreover, countries such as Pakistan and Vietnam will benefit as manufacturing centres, with China’s wage growth making its labour increasingly expensive.

Koch acknowledges there are risks to EM growth, but argues they are similar to those facing developed markets now, since the ‘quality gap’ – in terms of balance-sheet quality, debt levels and so on – has closed between EMs and DMs.

But EMs are more vulnerable in two broad areas: rising food prices and their perceived higher level of risk.

“Investors don’t yet recognise that the quality gap has closed, so growth markets and EMs continue to be a higher-beta asset class,” says Koch. Hence these markets suffer bigger redemptions than DMs in crisis times, even though the bad news often has little to do with EMs.

Of the Next 11 Asian nations, she is especially bullish on the Philippines, suggesting it is the most likely Asian EM in the group to move into the growth-market category, citing its strong demographics.

The country is “tracking the Indonesian story”, says Koch. The Philippines should be able to follow a similar trajectory, she adds, in terms of addressing its structural issues, reducing sovereign debt levels, achieving a sovereign rating upgrade and thereby becoming a widely accepted market for investors.

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