emerging market assets reach historic valuations · market technicals (supply/demand dynamics) and...

Emerging market assets reach historic valuations

Has the current crisis created a unique entry point for long-term investors?

March 2020


For professional investors and financial advisors only. Not for distribution to the public or within a country where distribution would be contrary to applicable law or regulations.

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Authors

Mike Hugman Portfolio Manager

Peter Eerdmans Head of Fixed Income

With thanks to:

Alan Siow — Portfolio Manager, Fixed Income

Marc Abrahams — Head of Multi-Asset Quantitative Analysis

Roger Mark — Analyst, Fixed Income

Tom Peberdy — Product Specialist, Fixed Income

The mechanics of capital markets have changed since the Global Financial Crisis (GFC). Consequently, the current ‘triple’ crises* do not pose a systemic risk to the banking sector. Yet unprecedented turmoil has swept through markets. Investors have seen a major repricing of emerging market assets, in some cases on a par with the GFC.

Before the recent turmoil, many emerging market assets were already on undemanding valuations, and structural investors’ positioning was relatively light in emerging market local debt and equities. Furthermore, the structural fundamentals of emerging market economies are typically strong. So, as short-term fundamentals and market liquidity begin to stabilise, we believe it is vital for long-term investors to assess the return potential in emerging markets as a whole and the bottom-up opportunities that this historic market dislocation has created.

*COVID-19; the break-up of OPEC+; and a liquidity event as post-GFC rules have pushed all market risk to asset managers and owners.


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Summary

The twin tail-risk events of coronavirus (COVID-19) and the failure of the latest OPEC+ agreement, combined with initially ineffective policy responses to the pandemic by the US and other developed markets, have led to a widespread liquidity event across global markets. This is impacting almost all asset classes.

Unlike during the GFC, it is now asset managers and investors — rather than investment banks — that are forced sellers1. This suggests the systemic risk to the real economy is materially lower.

However, for investors, it remains a highly uncertain and deeply unsettling time, with recent market turmoil seeing valuations dislocate completely from fundamentals in many emerging market debt assets.

While further downside tail risks remain, in this paper we take stock of how far we have come in terms of valuations and market positioning, and we provide a health check on emerging market fundamentals. Drawing on insights from previous crises, we show:

− Outflows have been larger and have occurred at a faster pace than at any time in the history of the emerging market asset class, in both bonds and equities.

− Pricing adjustments have been short of the magnitudes seen during the GFC, but valuations have reached a level where returns over subsequent periods have historically been high.

− Fundamentals across emerging markets, in terms of rates of inflation and company health, have never been stronger. And current accounts are in aggregate surplus. However, fragility in a minority of countries’ sovereign balance sheets, in some cases exacerbated by the fall in oil prices, has increased default risks.

We believe this points to a significant dislocation between current valuations and fundamentals, and provides an attractive entry point to emerging market assets for long-term investors. Of course, given the uncertainty associated with the global pandemic, near-term risks remain. Selectivity and the right combination of patience, conviction and agility are key.

A firm global policy backstop will be vital to realising these potential returns, but we have seen G20 central banks and finance ministries bring in measures in a matter of days, rather than the weeks and months it took during the GFC and eurozone crises. The IMF has lending capacity of US$1 trillion and will be key in addressing fiscal risks in reform-oriented emerging market sovereigns.

With pension funds now facing higher funding deficits, and developed market interest rates likely to remain at or below 0% for a number of years, we believe emerging market debt will become a more important long-term source of income for a range of institutional investors once market liquidity returns.

Valuations – significant moves point to compelling entry point

− The difference in real interest rates for the high-yield portion of the JP Morgan GBI-EM Index (local currency debt) and US real interest rates is now 450 basis points (bps), a level not seen during the GFC2. The GBI-EM real effective exchange rate (REER) is back to levels not seen since 2003 – before the Chinese/commodity super-cycle – while the US dollar has moved further into over-valuation territory.

1 As post-GFC rules have pushed all market risk to asset managers and owners. 2 The magnitude of the spread move in JP Morgan EMBI (high yield) has been materially impacted by the index’s composition, with more C-rated credits today than in 2008, resulting in a larger basis-point move than would otherwise have occurred. By rating, BB credits have widened around 65% of their 2008 range, B credits by around 50% and C credits around 75%.


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− Spreads on emerging market corporate debt have widened by around 60% of the relative increase we saw during the GFC. US high-yield corporate spreads have only moved by half of the range by which they widened in 2008/9. However, the index-level spread-widening belies a large number of underlying price dislocations and air pockets, given the breadth of the underlying corporate universe.

− In aggregate, emerging market hard currency sovereign spreads have widened by 65% of the equivalent margin seen in 2008/9, with high-yield markets widening by nearly 95% and investment-grade by 55%. More than 16 countries within the JP Morgan EMBI Global Diversified (hard currency debt) universe have spreads above 1000bps, despite the fact only two are in active default/restructuring. History suggests the most immediate spread reversion occurs in dislocated investment-grade markets.

− Emerging market equity price/book ratios3 (12-month expectations) are approaching 1.2x, vs 1.0x at the trough of the GFC. More than 40% of emerging market companies are trading below book value. Developed market equities are still trading at 1.6x book value, compared with a 1.2x trough in 2009. Emerging market equities have been relatively insulated, given the long-term lack of foreign investor participation. We see more room for downside in developed market equity multiples, as debt-funded share buybacks in the US are likely to be lower.

Fundamentals – strength belied valuations even before current dislocation

− Inflation has reached its lowest level in emerging market history, while aggregate current-account surpluses (ex-China) are positive and above long-term averages.

− Challenging fiscal dynamics are present in a minority of emerging markets; however, many higher debt/GDP frontier markets already have successful IMF programmes in place. Lower oil prices create further fiscal challenges for exporting economies.

− In the JP Morgan CEMBI Index (corporate bonds), leverage is on average 0.5 percentage points lower than that of US peers in equivalent ratings buckets, with wide-ranging support available from local banks and institutions to refinance in local currency.

− Despite lower trend GDP growth, net income margins for the emerging market equity universe are two percentage points higher than in 2008 and late 2015, thanks to material improvements in business models and structural reform in a number of sectors.

− While the following does not relate strictly to fundamentals, investors should also be aware that (unlike during the crises in 2008 and 1998) many larger emerging markets are no longer dependent on US-dollar financing and can switch to local currency in periods of market dislocation, such as the one we are currently experiencing.

Market technicals (supply/demand dynamics) and flows — fastest de-risking in the history of emerging market assets

− From a market-pricing perspective, the move up in emerging market local yields has been faster than during any other crisis, while the repricing of hard-currency spreads has been as fast as in October 2008.

− Emerging market foreign-investor outflows have totalled US$44 billion from major equity markets (ex-China), US$13.5 billion from China, and US$18.5 billion from major local debt markets. This is close to triple the pace of outflows seen in October 2008.

− On the hard currency side, we have seen seven consecutive days of >US$1.5 billion outflows from EMBI- and CEMBI-benchmarked mutual funds and exchange-traded funds (ETFs); since the GFC, we had previously not had a single day of outflows on that scale.

3 During sharp economic shocks, price/book ratios are more accurate than price/earnings ratios, which are more challenging given their reliance on analyst forecasts of earnings at a time of stress.


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− The unprecedented speed of outflows from emerging market assets has been matched globally with flows into US money market funds, which have been more rapid than in 2008/9. Holdings in US-dollar cash funds have already reached their GFC peak.

− The sharp de-risking of emerging market holdings comes despite a backdrop of zero net-inflows into emerging market local debt and equities (ex-China) since the end of 2014, which will have resulted in a material dilution of global investor exposure.

Triggers for a turn in the market — policy response has materialised; it is now about virus containment and oil prices

− G10 central banks and fiscal policymakers needed to act fast to restore basic market liquidity and commit sufficient fiscal resources to offset the supply-side damage from widespread quarantine measures. Fortunately, with strategies having been honed during the GFC and eurozone crisis, almost all necessary measures have been announced within two weeks.

− Crucially, when G10 bond markets came under pressure on 18 March due to concerns about the scale of debt issuance likely to be forthcoming, G4 central banks immediately upsized their quantitative easing programmes to effectively fund the additional fiscal spending in its entirely — a move that some economists would describe as signalling the advent of ‘helicopter money’.

− The role of the IMF will be critical in extending fiscal support to a range of emerging markets, first via short-term rapid financing instruments (RFIs) to address COVID-19 spending, for which US$50 billion is available; and then through extended programmes for which the Fund has US$1 trillion in capacity. The extension of US$60 billion of swap lines by the US Federal Reserve to four major emerging market central banks further increases support for emerging markets.

− COVID-19 remains the principal fundamental shock in the global economy. The continued recovery in Chinese economic activity and avoidance of a re-emergence of the outbreak in China will be important triggers, as will the peaking of the virus in Italy and other European countries. Progress in developing short-term treatments to reduce the severity of the disease, faster testing methods and the timely development of vaccines are key. Post-pandemic COVID-19 testing on a large scale would accelerate a return to work and drive a more rapid recovery of global economic activity.

− Oil markets remain under considerable pressure while Gulf Cooperation Council countries look to maximise market share at the expense of marginal producers such as US shale, Canadian heavy-oil, Mexican, UK and West African producers. However, the fiscal pain to Saudi Arabia (and other Gulf producers) would be significant if current oil prices are sustained into year-end. While Russia’s economic and fiscal sensitivity to oil are more modest, it is still suffering a significant hit to revenues at current prices, given its tax structure and higher marginal costs. Indications later in the second quarter of a material reduction in output from marginal producers might be key for rebuilding OPEC+; that is our base-case expectation following in-depth conversations with energy experts. There is also the increasing prospect that the US may curtail its own production to support oil prices.

Remaining risks

− Short-term mechanistic rebalancing represents an immediate technical risk for emerging market debt, with some funds likely to reweight portfolios in favour of underperforming equities, although we expect this to be funded mainly from developed market fixed income allocations.

− A further relevant factor is that market liquidity is likely to remain negatively impacted for a number of weeks while the large majority of traders are working from home.

− There remain many scenarios in which the impact of COVID-19 may be more negative than our base-case assumption, including a re-emergence of the virus in China or higher and later peaks in the UK and US. Supply-side damage through widespread business closures is a major risk to medium-term growth in countries that cannot deliver effective policy responses due to lack of fiscal space or inadequate monetary transmission.


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− Longer-term fiscal damage from lower oil prices is also a meaningful tail risk. We believe most major emerging market exporters are protected by fiscal savings, adjustments made during the last oil-price shock in 2014/15, and in several cases IMF programmes. But leveraged marginal producers such as PEMEX may be at risk.

Differences between the current crisis and the GFC

Other factors that lead us to believe that the sell-off and economic impact of the current crises should be less pronounced than in the GFC include the facts that:

− The current crisis was caused by an external shock, not by imbalances in the financial sector.

− Banks are now in a much stronger position.

− Investor positioning is now more modest and more transparent than pre-GFC.

− Today, emerging markets generally have stronger fundamentals.

On the following pages we share some key charts and data that we believe shed valuable light on recent market turmoil and its implications for investors in emerging market assets


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A major reset in valuations and positioning, despite solid fundamentals

Investors have seen a major repricing of emerging market assets, in some cases on a par with the GFC.

Real yield differential (high-yield EM hard currency vs US real rates) now at post-GFC high

Figure 1. Real yields, %

Source: Bloomberg, Haver Analytics. 1 January 2011 to 21 March 2020.

Real exchange rates in emerging markets are now at their lowest levels since 2003

Figure 2. Nominal and real effective exchange rate of the JP Morgan GBI-EM universe

Source: Bloomberg, Haver Analytics. 31 January 2003 to 31 March 2020.

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Emerging market equity price/book ratio is close to GFC-era trough

Figure 3. 12-month forward price/book ratio forecasts

Source: Bloomberg. January 2007 to March 2020.

Emerging market corporates: lower default cycles than US peers in the last 15 years

Figure 4. Last 12-month (LTM) issuer default rate, %

Source: Bank of America/Merrill Lynch as at 31 December 2019.

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However, emerging market corporate debt offers material spread pick-up per turn over leverage across rating buckets

Figure 5. Spread per turn of leverage by credit rating category, bps

Source: Bank of America/Merrill Lynch. Leverage as at June 2019. Spreads as at March 2020.

The pace of daily outflows from foreign investors overall has been triple that seen during the GFC

Figure 6. Bond and equity flows, US$m

Source: Bloomberg. January 2007 to March 2020.

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The pace of mutual fund and ETF outflows from emerging market debt has been the fastest on record

Figure 7. Cumulative flows into emerging market debt funds by year (2020: year to 18 March), US$m

Equity flows have been protected by light positioning among retail investors

Figure 8. Cumulative flows into emerging market equity funds by year (2020: year to 18 March), US$m

Source for Figures 7 and 8: Trounceflow. 1 January 2010 to 18 March 2020. Years shown are those where major outflows were recorded.

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Core inflation across emerging markets now sits at a 25-year low

Figure 9. Core inflation, % year on year

Source: Bloomberg, Haver Analytics. December 1996 to January 2020. Universe: JP Morgan ELMI constituent countries.

Current account balances are in a healthy surplus

Figure 10. GDP-weighted current account deficit in emerging market economies (ex-China), % GDP

Source: Haver Analytics. January 1994 to December 2019. Universe: 20 selected emerging markets.

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Emerging market local currency debt

How far have we come?

− 12 March 2020 was the worst single day of unhedged returns in the history of the GBI-EM Index, with a 43bps (11.0 standard-deviation) move in hedged yields. At the time of writing, March 2020 has seen two of the worst 10 days in the history of the index.

− The rise in GBI nominal yield relative to US Treasuries has been of the same pace and magnitude as in October 2008.

Where we see the most pronounced opportunities

− Russia: In response to a challenging period over recent years, led by geopolitics, Russia has taken unprecedented steps to anchor its macroeconomic framework. Inflation is at historic lows and the twin fiscal and current account surpluses are at historic highs. Despite the fall in oil prices and disagreements within OPEC+, we believe Russia can maintain its current fiscal policy for several quarters, drawing on its exceptionally high levels of savings, without debt/GDP approaching a level where its investment-grade sovereign rating is at risk.

− Peru: For many years, Peru was an outlier in emerging markets, operating an economic model which emphasised only partial floating of the exchange rate and accumulation of larger foreign exchange (FX) reserves. This was due to its history of crisis and continued partial dollarisation of the economy, and led to an exceptionally strong inflation outcome for the central bank, at or below its 2% target. Tight fiscal policy has resulted in very low levels of debt/GDP, and we believe current policy can be financed from savings for several quarters. Monday 16 March saw the largest one-day increase in the JP Morgan Index yields in history, out of line with these long-term fundamentals, in our view.

− China: The entry of the Chinese local bond markets into the GBI-EM Index has only just started, but our conviction based on the low correlations to global markets and lack of short-term positioning, together with the effective Chinese response to the original coronavirus outbreak, gave us confidence to maintain a sizeable overweight in the Chinese currency and local bonds. Recent outperformance highlights the importance of Chinese bond-market integration as providing emerging market local-currency investors with a strong, investment-grade market with low liquidity risks and correlations to other global assets.

Volatility and sell-offs — JP Morgan GBI-EM Index

Rank Date 1-day move Standard deviations

1 12-Mar-20 -4.9% 7.8

2 06-Oct-08 -4.7% 7.6

3 22-Oct-08 -4.5% 7.2

4 20-Jun-13 -3.9% 6.3

5 18-Mar-20 -3.9% 6.2

6 15-Oct-08 -3.4% 5.4

7 16-Oct-08 -3.3% 5.3

8 10-Oct-08 -2.9% 4.7

9 08-Oct-08 -2.9% 4.7

10 10-Nov-16 -2.7% 4.4

Source: Bloomberg, Ninety One. March 2020.


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Figure 11. Yield less starting yield (GBI vs. US Treasuries), %

Source: Bloomberg. Ninety One. March 2020. The chart tracks the spread of the JP Morgan GBI-EM yield vs. US Treasuries for six other crisis periods and today. Crisis periods start on the following dates and last for one year: 13 August 2003; 12 June 2007; 8 April 2011; 14 May 2013; 20 April 2018; 12 February 2020 (to 19 March 2020).

Emerging market corporate debt


− March 2020 has seen five of the worst 10 total-return days for the CEMBI since 2004.

− Spreads have widened by around 60% of the total magnitude of the GFC period, despite the material improvement in quality and diversification of the asset class.


− We believe the current environment offers dedicated investors opportunities to invest in leading emerging market corporates at historically attractive spread valuations. The index-level spread dislocation does not tell the whole story, as much wheat has been thrown out with the chaff; we believe that discerning and diligent investors will be able to find many specific entry points at very attractive valuations within the wider universe — opportunities that would not be obvious from an index-level inspection.

− The key sector to have been affected is the resources sector and here the selling has been rather indiscriminate, creating many dislocations within the oil & gas value chain — for example downstream players that benefit from lower oil-feedstock prices being sold off as aggressively as producers whose revenues are directly affected by lower prices. Similarly, we are also seeing recent market behaviour give rise to relative value opportunities between regions, as not all national oil producers are created equal.

− Away from resources, the other key sectors to be directly affected are the airline and tourism industries as a result of the sharp decline in demand due to COVID-19. However, even within these sectors, there will be relative winners and losers due to other considerations such as M&A triggers and national-champion/sovereign support scenarios emerging, in our view.

− Equally, we expect sectors such the financial, technology, media and telecommunications (TMT), and the utility sectors to remain defensive and resilient in the current environment, and so the current dislocation may create attractive entry points.

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− From a regional perspective, while China was ‘ground zero’ for the virus outbreak, it was also the first market to see a dramatic policy response and, as a result, asset prices were the first to correct and recover. However, Chinese and Asian corporate bonds have not escaped the impact of the second risk catalyst (the oil shock), which initially hit the resources sector the hardest, but the second and third waves of repricing have left no sector untouched.

− We currently see the Chinese property sector as offering a compelling opportunity, with spreads widening to almost GFC levels, despite most real estate developers having limited direct exposure to the oil shock. Many of these companies have resumed operations following the COVID-19 disruption and are benefiting from loosened financial conditions onshore. Many developers have pre-funded their 2020 and 2021 financing needs and we believe this means they could easily weather a prolonged closure of offshore capital markets, even as their operations largely recover to pre-COVID-19 levels.

− Away from the property sector, we believe market dislocation has created attractive entry opportunities in the financial and technology sectors, both of which have been resilient so far.

− Away from Asia, select Latin American corporate sectors look attractive to us, with Mexican, Brazilian and Andean corporate spreads having dislocated heavily from fundamentals. In particular, senior financial spreads for certain systemically important banks appear very attractive on a risk-adjusted basis, as well as spreads for corporates that are not directly affected by oil price ructions, but which have been nevertheless caught up in the sell-off.

− In the CEEMEA region4, Turkey is a net importer of oil so should benefit from lower oil prices. It has so far not seen a wide-scale outbreak of COVID-19, but spreads have widened in sympathy. MENA and Gulf Cooperation Council corporate (and sovereign) bonds have heavily repriced to reflect the new world order in oil prices; including in Saudi Arabia, which arguably has the most direct ability to affect the future outcome of the current oil-price wars.

− Somewhat counterintuitively, despite Russia being one of the main protagonists of the oil price war, Russian corporate spreads have been very resilient, due mainly to technical factors (very limited incremental supply and strong domestic investor involvement) which has meant that Russia is one of the few regions where corporate spreads have not widened aggressively.

Volatility and sell-offs — JP Morgan CEMBI


1 18-Mar-20 -3.1% 14.3

2 24-Oct-08 -2.6% 11.9

3 12-Mar-20 -2.5% 11.8

4 10-Oct-08 -2.3% 10.9

5 08-Oct-08 -2.1% 9.9

6 09-Mar-20 -2.0% 9.1

7 22-Oct-08 -2.0% 9.1

8 16-Mar-20 -1.8% 8.2

9 19-Mar-20 -1.7% 8.0

10 20-Jun-13 -1.7% 7.8


4 Central & Eastern Europe and the Middle East.


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Figure 12. Absolute changes of JP Morgan CEMBI spread vs. US Treasuries, bps

Source: Bloomberg. Ninety One. March 2020. The chart tracks the spread of the JP Morgan CEMBI vs. US Treasuries for five other crisis periods and today. Crisis periods start on the following dates and last for one year: 20 July 1998; 12 April 2002; 29 August 2008; 30 July 2014; 6 March 2015; current crisis: 12 February 2020 (to 19 March 2020).

Emerging market hard currency sovereign debt


− March 2020 has seen five of the worst 10 total-return days for EMBIGD since 2004.

− On aggregate, emerging market hard currency sovereign spreads have by widened 65% of the magnitude seen in 2008/9, with high-yield markets widening nearly 95% of the GFC range, while investment-grade markets have widened around 55%. US high-yield spreads have only moved by half of their GFC range, so from this perspective emerging market credit has cheapened materially relative to developed market credit.


− Ecuador: With bonds priced at 35 cents at the time of writing (12 March), the market is now pricing in a debt restructuring as severe as the debt repudiation undertaken by the hard-left government in 2009. But Ecuador is a very different economy to the one it was 10 years ago. Today, debt/GDP is 50%, with interest/revenue of only 17%. The differences don’t stop there. The country is also now in an IMF programme (albeit with minor delays) and has no major bond maturities until March 2022. Furthermore, the government is strongly committed to reform, even though it has faced some challenges in areas like fuel subsidies. And it has already announced measures to balance the budget in the face of lower oil prices. The major medium-term risk is the presidential election next year, with at least one radical left-wing candidate expected to run. However, fundamentals are vastly different to what they were in 2009 and we believe market pricing is ignoring this fact.

− Angola: At 60 cents, we see significant price asymmetry in Angolan hard currency bonds as we believe the risk of any restructuring within the next 12 months is low. After the 2015 oil price shock, Angola engaged in significant fiscal and economic reform supported by the IMF. Since then, it has reduced its non-oil primary deficit by almost 40% and moved the fiscal breakeven oil price from the high 80s to the low 50s. We also expect that the government will have enough levers to consolidate fiscal balances even further to counteract the impact of lower oil revenues. In addition, the government has several funding sources available should the market remain shut for eurobond issuance, which could cover gross external financing needs over 2020. The current government in Angola continues to make resolute progress towards reshaping the country after the Dos Santos era.

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− Zambia: The country’s bonds are currently trading at 46 cents. We had not been invested in Zambia for almost two years due to concerns around spending and fiscal profligacy, but over the last 12 months we have seen significant changes which we believe were being underappreciated by the market even before the latest sell-off. Firstly, we see the country making a strong move closer to the IMF and a clear recognition from the new finance minister on the need to deal with the main fiscal issue in Zambia, which is agreed-but-not-yet-disbursed external infrastructure-related loans. To that end, Zambia has announced that it is cutting US$5 billion from the US$7 billion pipeline, which — along with measures already taken on electricity prices — should be enough to ensure fiscal sustainability. Secondly, we see very high willingness to pay as well as continued ability as we head into the August 2021 elections. We believe that for investors this means getting paid yields in excess of 40% to hold an asset which should continue to be serviced with upside from further economic reforms. But the market is painting a much more negative picture.

Volatility and sell-offs — JP Morgan EMBI GD Index


1 22-Oct-08 -5.8% 15.3

2 10-Oct-08 -5.6% 14.9

3 18-Mar-20 -4.9% 12.9

4 12-Mar-20 -4.7% 12.3

5 09-Mar-20 -3.8% 10.0

6 19-Mar-20 -2.9% 7.5

7 14-Nov-16 -2.7% 7.2

8 16-Mar-20 -2.7% 7.1

9 20-Jun-13 -2.6% 6.9

10 06-Oct-08 -2.5% 6.7


Figure 13: Absolute changes in JP Morgan EMBI Global Diversified index yield spread vs. US Treasuries, bps

Source: Bloomberg. Ninety One. March 2020. The chart tracks the spread of the JP Morgan EMBI yield vs. US Treasuries for six other crisis periods and today. Crisis periods start on the following dates and last for one year: 20 July 1998; 12 April 2002; 29 August 2008; 7 July 2011; 30 July 2014; current crisis: 12 February 2020 (to 19 March 2020).

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Figure 14: Absolute changes in JP Morgan EMBI Global Diversified index (investment grade) spread vs. US Treasuries, bps

Source: Bloomberg. Ninety One. March 2020. Notes as per Figure 13.

Figure 15: Absolute changes in JP Morgan EMBI Global Diversified index (high yield) yield vs. US high yield,

bps

Source: Bloomberg. Ninety One. March 2020. The chart tracks the spread of the JP Morgan EMBI yield vs. US high yield (from Barclays Bloomberg Aggregate) for two crisis periods. Crisis periods: 29 August 2008 (for 1 year); current crisis: 12 February 2020 (to 19 March 2020).

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Emerging market equities


− March 2020 has seen three of the worst 10 days in MSCI EM return performance since 2002, although the declines are not as severe as in 2008. For some years there has been a lack of foreign-investor participation in emerging market equities, making the asset class less susceptible to panic-driven outflows.

− Both the MSCI EM Index and MSCI World Index have fallen by around half the amount, in percentage terms, of the fall during the GFC. In the case of emerging market equities, we believe this reflects the already limited investor positioning. In the case of developed market equities, valuations remain close to long-term averages, rather than outright cheap.


− Our 4Factor equity team has favoured Chinese equities over emerging market equities for some time now. Chinese equities have outperformed by around 20% in March (month to date and at the time of writing). A rapid and seemingly effective response to the original COVID-19 outbreak, in both medical and economic terms, has insulated China from the worst impacts of the more recent global panic. Limited foreign ownership and liquidity support from the Chinese authorities have reduced correlations with global markets.

− Our equity colleagues see real value in some long-term growth companies, which they think are finally trading on valuations that make it compelling to access their exceptional long-term growth prospects.

Volatility and sell-offs — MSCI Emerging Markets Index


1 06-Oct-08 -9.5% 8.1

2 08-Oct-08 -8.1% 6.9

3 22-Oct-08 -7.8% 6.7

4 24-Oct-08 -7.8% 6.7

5 16-Oct-08 -7.5% 6.4

6 15-Oct-08 -7.5% 6.4

7 06-Nov-08 -7.1% 6.0

8 12-Mar-20 -6.7% 5.7

9 16-Mar-20 -6.5% 5.5

10 09-Mar-20 -6.3% 5.4



19

Figure 16: Drawdowns from crisis start, MSCI Emerging Markets Index vs. MSCI World index, %

Source: Bloomberg. Ninety One. March 2020. The chart compares the percentage drawdowns in the MSCI Emerging Markets index vs. the MSCI World index for two crisis periods. Crisis periods: 29 August 2008 (for one year); 12 February 2020 (to 19 March 2020).

Conclusion

In recent weeks, markets have been hit by a triple shock of COVID-19, the break-up of OPEC+, and a liquidity event as post-GFC rules have pushed all market risk onto asset managers and owners. This has created a repricing of emerging market assets, in some cases on a par with the global financial crisis — particularly in the hard-currency debt market. This is despite the current crises not presenting a systemic risk to the banking sector.

Many emerging market assets, such as local currency debt and equities, were already on undemanding valuations and with relatively light structural investor positioning. As fundamentals and market liquidity begin to stabilise, we believe it is vital for long-term investors to look at both the asset-allocation return potential in emerging markets as a whole, and also at the bottom-up opportunities that this market dislocation has created, and that our portfolios are well placed to capitalise on.

Forecasts are inherently limited and are not a reliable indicator of future results.

Opinions based on current market conditions; subject to change without notice and without any obligation to update.

Past performance is not a reliable indicator of future results, losses may be made

The value of investments, and any income generated from them, can fall as well as rise. Forecasts are inherently limited and are not a reliable indicator of future results.

Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.

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2008 MSCI DM 2008 MSCI EM 2020 MSCI DM 2020 MSCI EM

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Indices

Indices are shown for illustrative purposes only, are unmanaged and do not take into account market conditions or the costs associated with investing. Further, the manager’s strategy may deploy investment techniques and instruments not used to generate Index performance. For this reason, the performance of the manager and the Indices are not directly comparable.

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SummaryValuations – significant moves point to compelling entry point Fundamentals – strength belied valuations even before current dislocationMarket technicals (supply/demand dynamics) and flows — fastest de-risking in the history of emerging market assetsTriggers for a turn in the market — policy response has materialised; it is now about virus containment and oil prices Remaining risksDifferences between the current crisis and the GFC

On the following pages we share some key charts and data that we believe shed valuable light on recent market turmoil and its implications for investors in emerging market assetsA major reset in valuations and positioning, despite solid fundamentals Emerging market local currency debtHow far have we come?Where we see the most pronounced opportunities

Emerging market corporate debtHow far have we come?Where we see the most pronounced opportunities

Emerging market hard currency sovereign debtHow far have we come?Where we see the most pronounced opportunities

Emerging market equitiesHow far have we come?Where we see the most pronounced opportunities

Conclusion

emerging market assets reach historic valuations · market technicals (supply/demand dynamics) and...

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