Cautious allocations to emerging markets

While it may be too early for private clients to make a wholesale move back into emerging markets, there are some compelling long-term stories in the developing economies. “The thesis of decoupling was completely invalidated by this credit crisis,” said Gregory Shore, CIO at ING Private Banking and CEO at ING Private Capital Management (IPCM). Emerging markets financial markets have in fact suffered more than their Western counterparties. “We see the exact same consequential reactions and leveraged effects that we saw in past crises in history,” said Dr Shore. However, a number of larger emerging market economies will hold up better than they have in past, and comparatively well compared to Western economies, he said. A long term structural overweight of 10 per cent to emerging market equities is embedded in the firm’s proprietary equity benchmark and European portfolios at IPCM, which is the central investment engine of ING global private bank, are neutral-weighted on a tactical basis. “You have to see a stop in the deterioration of the economic growth prospects of the West, or a stabilisation at least, before you start making the move back,” he said. A stabilisation or even picking-up of the commodity market will be an important signal that this is happening, he said. “Right now, a tidal wave of foreign investors’ money is leaving emerging markets and coming back home to security and safety,” said Dr Shore. This is pushing prices down enormously in emerging markets, which are heavily dependent on foreign capital. “Whatever your macroeconomic or financial market read of the situation, there is no way you can fight a tidal wave; if you jump in you will be swept away,” Dr Shore explained. At IPCM, exposure to emerging markets is gained through a combination of active managers with Exchange Traded Funds (ETFs), typically providing global exposure, sourced from the iShares MSCI ETF family. “On some more aggressive profiles, we split the ETF allocation between Asia ex-Japan, Eastern Europe and Latin America. This enables to rep-licate the index while making specific bets using regional tilts,” he said. “On the active management side, we particularly like the work of Aberdeen and Magellan and we are currently using their global emerging markets funds,” he said. According to Walter Pfaff, head of asset allocation and research at LGT Capital Management in Switzerland, inefficiencies in the emerging markets will increase and therefore active managers, who have the flexibility to over- or under- weight specific countries, are favoured over ETFs, which are often very illiquid and not always available. “Differences between countries are also rising. Some countries exhibit a very big deficit, while other sets of countries have really nice surpluses. Eastern European countries are very vulnerable, they will suffer the most and they will have to adapt by lowering their credit expansion, which may lead to below-zero growth. We favour Asia and South America over Eastern Europe,” said Mr Pfaff. But cautiousness is required. “In our medium-term balanced fund, we have a two per cent allocation to emerging markets equities, which is an underweight position relative to our internal benchmark,” said Mr Pfaff. He said that he would rather “be a little bit late than too much early,” in increasing exposure to emerging markets equities once again. In fixed income emerging markets, a very long term perspective is needed. “We have a roughly neutral position in emerging market bonds, between five and six per cent. In the past, emerging markets fixed income was one of the best performing classes throughout all defaults,” he said. Burkard Varnhold, CIO at Bank Sarasin & Co in Basel sustains that “Asia is structurally much better prepared for this storm than the US and Europe,” because Asian countries have current account surpluses. “And the biggest risk for any country these days is to run a current account deficit, possibly combined with external debt denominated in foreign currency. That’s a very dangerous combination, as we found out in the case of Hungary, Ukraine and Austria.” Nevertheless, he added: “We had virtually no exposure to the Asian market throughout the year, but we are looking into it.” According to the latest Merrill Lynch monthly survey, eighty-five per cent of managers who focus on Asia or emerging markets expect the Chinese economy to weaken in the next 12 months. However, China is favoured over any other country.