Although professional investors - on average - are still considerably underweight equities, there is one category they are massively allocating to. Never before has the allocation jump in emerging markets equities been so large in three months. EM is hot.
So says Bank of America’s (BofA) Global Fund Manager Survey, released on Tuesday. In one sentence, the latest survey of more than 250 CIOs, fund managers and strategists concludes that the pain trade is still in full swing, even if fund managers are less pessimistic than a year ago.
On average, investors surveyed are holding over 5 per cent cash. That is less than the peak above 6 per cent last October, but more than average. Allocation to equities did rise somewhat since the low point in September last year, but still surveyed investors are on average 31 per cent underweight equities.
En Masse into EM
However, one share class in particular does meet with investors› approval. In EM stocks, allocation-wise, there is euphoria, according to the survey. “February saw a big allocation jump towards EM equities. This allocation rise over three months (February versus November) was a whopping 51 percentage points, the biggest ever.”
BofA - emerging market equities Feb 2023
One investor that has become more positive on emerging market equities is Robeco. From its multi asset portfolios, the Dutch fund house now has an overweight position in emerging market equities, at the expense of its position in developed countries. “We are at the start of a new relative upswing that could last for years to come,” portfolio manager Arnout van Rijn writes in an outlook. “The asset class has put the many years of underperformance behind it,“ Van Rijn said.
He cites the “plus point that central banks there have not resorted to the kind of inflationary QE measures as in the West”. And meanwhile, the likelihood of monetary easing in emerging markets is higher than in the US and Europe, Van Rijn foresees, thanks to more favourable inflation rates in key emerging markets, plus higher interest rates there.
‘Buy now!’
There is a “significant yield gap” between developed and emerging markets, Van Rijn stresses, referring to a report published in September with its five-year return expectations. Robeco then predicted 4 per cent annualised returns for developed markets and 5.25 per cent for emerging markets. Van Rijn: “We believe this long-term call is very opportune from a tactical point of view today. Buy now!”
In their fund tips for 2023, two of the three banks also chose to invest in emerging market equities. ING suggested a specific focus on Vietnam (in addition to a broadly diversified portfolio). “A promising stock market after the bursting of a property bubble there last year,” the bank stated in January. Van Lanschot Kempen picked a broad fund in emerging markets, with the bank citing the re-opening of China’s economy, following the loosening of its rigid zero covid policy.
Bonds
Not only emerging market equities are attractive, according to Robeco’s Van Rijn, so are bonds. However, he does warn of the additional risk that some securities carry, such as Chinese real estate bonds. That said, emerging-market bonds involve spread levels of 200 to 250 basis points. Van Rijn: “Which may not seem like much, but just remember that we are not seeing recession risk here - unlike the US or Europe.”
JP Morgan Asset Management points to the risk of higher interest rates in the US in a recent report on emerging market debt. “While both general and core goods inflation are slowing, wages and core services remain under pressure. If US activity and core inflation remain resilient, we could see higher than expected final interest rates in the first half of 2023 and prolonged pressure on emerging market asset prices.”
The fund house itself prefers countries with high real yields and countries where central banks have room to cut interest rates or respond dovishly to easing US Treasuries. “EMFX (emerging market foreign exchange) also has room to perform well.”
As for hard currencies, of course much depends on the final path chosen by the US Federal Reserve. JP Morgan AM does argue, though, that lower interest rate volatility will provide more support for emerging market hard currency debt. “Although the value is more concentrated in weaker credit names, we continue to favour a core overweight in BB-rated bonds, with selective and tactical opportunities in lower-quality names.”