What you thought you knew about emerging markets

5 minutes  

Investing in emerging markets has been around for 30 years, a period considered short when compared to the history of the stock market, but long enough to have amassed some myths when it comes to investing.

In the recent Netwealth Webinar titled ‘How to spot investment opportunities in emerging markets’, Orbis Investment Advisory Director Dr Graeme Shaw, set the record straight on some of the most popular myths about investing in emerging markets, including economic growth.

Myth 1 – Rapid economic growth is a key indicator

The myth goes something like this - rapid economic growth is good for the stock market, which in turn is beneficial for investors.

But according to Dr Shaw, this myth is based on the almost 30-year history of the MSCI emerging markets Index, which indicates the outperformance of emerging markets when compared to developed markets.

“A closer look at the data shows no correlation between GDP per capita (GDP growth) and real stock market performance returns. A perfect example of this is China which has experienced absolutely phenomenal GDP growth, but has been overall, a disappointing place for investors.”

Myth 2 - High rates of population growth is a reason to invest

The fact is the trends in emerging markets and developed markets are not dissimilar when it comes to replacement rates and population growth.

“Currently, most of the world has a fertility rate that is sitting either equal to or slightly lower than the replacement rate required to keep population growth consistent,” said Dr Shaw.

He added: “Emerging markets such as Brazil, China, Korea and others are no different in this respect to developed markets, showing similar replacement rates when it comes to population growth.”

Fact not fiction

The fact that emerging markets is a relatively new concept in stock market history makes it easy for myths to gain momentum.

So how can investors overcome this lack of historical data to not only dispel fiction, but also to make concrete investment decisions?

According to Shaw, investors should treat emerging markets just like any other investment.

“Own it when it’s out of favour and well-priced. If it doesn’t fulfill these two base criteria, go and look elsewhere for investment opportunities.”

He said the positive news is that currently emerging markets are really starting to look quite cheap. This can be partially attributed to the fact that the MSCI Emerging Market Index has underperformed developed markets by more than 50 per cent over the past 5 to 6 years.”

Another positive feature of emerging markets is the gap in price to earnings between emerging and developed markets. According to Shaw, you can buy emerging markets at a 30% discount to developed markets even though the return on equity is similar across both.

The final factor to consider when investing in emerging markets is the spread in valuations, which are currently a lot wider across emerging markets than they have been over the past 15 years.

“This wide spread means that investors aren’t limited to indices, they can also invest in the cheaper parts of attractive markets, an option that is valued by stock pickers like ourselves,” said Shaw.

Why the hesitation?

With all these positives, why then is there a sentiment of hesitation about emerging markets? According to Shaw rising US interest rates and a potential bear market are to blame. However historical data proves these fears to be unfounded.

“Our research shows no correlation between US interest rates and the relative performance of emerging markets, in fact it shows that emerging markets tend to be impacted positively at these times. With regards to the possibility of a bear market, again our data shows that in the three historical bear markets emerging markets were not impacted over the long-term.”

According to Shaw, the most common reasons given for investing in emerging markets are myths that should be disregarded and these stocks should be evaluated on the same factors as stocks across developed markets.

Shaw said: “Based on standard valuation metrics such as price/book and price to earnings ratio, emerging markets appear cheap. They’ve achieved a very similar return on equity to developed markets so don’t really deserve the big price/book discount they have.  This combined with the wide valuation spreads means you are getting stocks at very low prices.”

This is the investment approach Orbis Global Equity Fund takes.

“It has seen our Orbis Global Equity Fund beat the index by more than 5 per cent per annum over the past 27 years. It has also been successfully applied through our sister company in South Africa, Allan Gray Proprietary Limited, which has beaten the local stock market by a similar amount for the past 40 years. A track record that substantiates treating all stocks equal when it comes to investing.”

Performance is as at 30 June 2017 and represents the overseas Global Equity Fund. Australian investors must invest through the Australian based Global fund (Fund). Equity Trustees Limited is the Fund’s responsible entity. Please read the Fund’s latest product disclosure statement, available on www.orbis.com.au and www.netwealth.com.au, prior to investing. Past performance is not a reliable indicator of future performance.