US investors raise allocations to emerging markets

JP Morgan Asset Management's Richard Titherington discusses why Brazil and Russia are attractive and why their price-to-earnings and price-to-book ratios are lower than in China and India.

Richard Titherington is chief investment officer and head of emerging markets equity at JP Morgan Asset Management in London. He oversees the firm's global emerging markets, including emerging Europe, the Middle East and Africa, and Latin America funds.

A JP Morgan employee since 1986, Titherington was appointed as a managing director in April 2001 and appointed head of the global emerging markets business in December 2001. Prior to 1994, he was a US and international pension fund manager, working in the UK until he transferred to Hong Kong in 1992.

What's the overall breakdown of where AUM is sourced for your emerging-markets business?
Our overall emerging-markets business is about 65% sourced from Europe, 20% from the Americas and 15% from Asia.

But the US is growing in importance -- 18 months ago, the breakdown would probably have been 70% Europe, 15% US and 15% Asia. That's because of a growing awareness in the US of importance of emerging markets, whereas emerging markets have been a big focus for Europeans for some time.

Why is Russia so highly favoured by emerging-market investors at present, and where are most of the inflows into Russian assets coming from?
A couple of reasons: firstly, among the Bric countries -- which rightly attract a lot of attention -- Russia is the cheapest by price-to-earnings (P/E) and price-to-book (PTB).

People are a little concerned that emerging markets [stock markets] have risen a lot and are not as cheap as they once were. Russia has not risen so much -- P/E there is around 7.2x and PTB around 1.1x; emerging markets on average are more like 11.6x P/E and 2x PTB. China and India are even higher, with P/E at 12.7x and 16.3x, respectively and PTB at 2.5x and 3.2x.

Having said that, P/E should be higher in those countries than in Russia -- they both have more broadly based economies and more growth potential.  The Russian market is still dominated by energy, both from an economic and stock-market standpoint -- which can be positive or negative depending on how you look at it -- and it makes the Russian stock market volatile even by emerging-market standards.

Europeans are the biggest emerging-market investors and are much more comfortable with the Russia story than clients in the US. That is reflected by the fact that our US-registered Russia fund is a lot smaller ($29 million in AUM) than our Luxembourg-registered Russia fund ($2.2 billion).

How have those two funds performed and what inflows/outflows have you seen?
The Luxembourg Russian Fund is up 1.40% as of February, compared to +0.19% for the benchmark -- as against a gain of 168.67% for 2009 against the benchmark return of 142.94%. The US Russian Mutual Fund is up 1.27% year to date (versus the benchmark -2.98%) as of February, following a 165.44% performance last year, against the benchmark's 104.22%.

The differences here will be driven by the make-up of the benchmarks against which the portfolios are run. You will see that the portfolios performed similarly, but the benchmarks were different.

We are one of the largest foreign investors in Russia and have seen significant net inflows -- around $1 billion -- in the past six to 12 months, the vast majority from our Luxembourg fund. Over the past two and a half years, we've seen both sides of story -Russian stocks have dropped heavily and assets have flowed out, and then it the stock market has risen strongly and attracted assets in.

And how about Brazil? What are the attractions of the country and how has Brazil fund performed?
Brazil is the best-performing stock market among the Brics over most time periods -- certainly over three (+19.7%  annualised), five (+27.4%) and 10 years (+19.2%), according to the MSCI Brazil.  In 2009, it was up 128.6%, although in 2010 it's down 6.9% as of the end of February,

The market has both the commodity angle of Russia -- a big and fast-growing iron ore industry, for example -- and quite a buoyant consumer side to the story, which is linked to the government's success in bringing down inflation.

Investment flows into Brazil were pretty broad-based. The US is certainly more comfortable with Brazil than with Russia, but there was still quite a good level of flows from Europeans. In our Brazil fund, there are pretty much equal amounts of AUM sourced from Europe and the US, while Asian investors contribute less than 10%, more into Russia than Brazil.

What are the biggest concerns you have for emerging-market investments at present? Do you see any political intervention imminent, such as measures taken by Brazil to try to cool appreciation of the real?
We're always concerned about governments intervening in markets -- our preference is for open markets.

I don't expect any further measures coming out of Brazil, for example, although other countries are looking at what they've done, so it's possible it may spread. In particular, Russia has raised the possibility of a similar tax.

Other than that, there are always concerns for both countries' currencies in that they are both commodity-related, which increases the level of volatility. We've seen them move a lot in recent years. Freely floating currencies are good things, but this is one of the things to account for as a result.

What exactly did the Brazilian measures consist of?
Brazil most recently took measures to cool the appreciation of the real in October. On October 20, the Brazilian Government imposed a 2% tax on FX contracts for purchases of securities or bonds. It is called an IOF tax (imposto sobre operações financeiras), which, roughly translated, means 'tax on financial operations'.

Every time someone wants to remit money into real, they will have to pay this 2% tax. Once the money has been remitted into Brazil, there is no further IOF tax to pay as long as the money stays in the country. If it is remitted out and then remitted back in at a later stage, then the 2% tax would become payable again.

Prior to this instance, Brazil had imposed a similar tax in January 2008, replacing a previous tax that had expired at the end of 2007. This IOF tax was repealed in October 2008, after the real had quickly fallen 40% against the dollar during the height of the economic crisis.

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