Emerging markets are entering a “sweet spot,” according to Michael Bolliger, chief investment officer for emerging markets at UBS Wealth Management.
A perfect storm, consisting of the coronavirus pandemic recovery, rising commodity prices, a weak dollar and overpriced US stocks, has sent investment flooding into the area. Emerging market equity ETFs have benefited from the favourable environment, as have those that offer exposure to high yield bonds.
A Bank of America survey recently found that 62% of fund managers who oversee half a trillion dollars in assets, are overweight on emerging market equities, the Financial Times reports.
Fund managers with over $0.5trn in AUM are overweight on EM equities
According to the publication, investors have also pointed to the low valuations that some emerging market assets have as an advantage, especially at a time when many consider US stocks to be overvalued.
On 27 January, the MSCI Emerging Markets index traded at 16 times expected earnings (over the next 12 months), according to Bloomberg. In comparison, the S&P 500 had a PE ratio of 22 times on the same day.
Sustainable gains across the board
The iShares MSCI Emerging Markets ETF [EEM], which is considered to offer the broadest exposure to emerging markets, has gained 11.06% in 2021 so far (through 11 February’s close). The iShares ESG Aware MSCI EM ETF [ESGE], which focuses on more sustainable companies, has gained 11.23% in the same period, while the Goldman Sachs ActiveBeta Emerging Markets Equity ETF [GEM] has grown 9.27%.
UBS Wealth Management was particularly positive on Russian and Latin American stocks, Bloomberg reported at the end of January. While the Goldman Sachs ActiveBeta Emerging Markets Equity ETF had 8.1% of its holdings in Latin America and 3.5% in Russia on 10 February, its top weightings were China and Taiwan at 33% and 15.8%, respectively.
Chinese and Taiwanese stocks have performed strongly so far this year. As of 10 February, all three of the above ETFs’ largest holdings were Taiwan Semiconductor Manufacturing (TSMC) [2330.TW] and Tencent Holdings [0700.HK].
Shares in TSMC had grown 19.2% so far this year (through 5 February’s close), while Tencent’s share price was up 32.2% year-to-date (as of 11 February’s close).
Russia and Latin American targeted as growth markets
For those looking for direct exposure to the Latin American and Russian markets, there are several specialised ETFs.
The VanEck Vectors Russia ETF [RSX], which offers investors exposure to Russian incorporated companies or those with more than 50% of their revenue drawn from Russia, has grown 2.65% for the year to date (through 11 February’s close). This performance closely resembles Gazprom’s [OGZPY], the fund’s largest holding, which has gained 3.94% so far in 2021, as of 11 February.
Meanwhile, an ETF such as the Franklin FTSE Brazil ETF [FLBR] offers exposure to Latin America’s largest economy. The fund made a strong start to the year, gaining 4.4% in the fortnight to 14 January, but has since fallen 6.88% (as of 11 February’s close).
Its top holding, the country’s largest iron ore producer Vale SA [VALE], saw a similar run to the 14 January in the wake of strong steel demand in China. But a subsequent fall in demand across Asia has since brought Vale’s share price down 4.8% (as of 11 February’s close).
Sri Lanka market rallies
Sri Lankan stocks have witnessed the strongest rally among emerging markets so far this year, according to Bloomberg. Local traders had bought LKR155bn worth of stocks by 27 January, 45% of the total domestic purchases in 2020, the publication noted.
45%Sri Lankan domestic purchases by local traders
Joshua Crabb, a manager at Robeco, attributed the rally to abundant “global liquidity, substantial rate cuts and domestic retail participation,” as well as a weakening currency, which has made its exports and tourism more competitive. While few ETFs offer investors exposure to the area, the iShares MSCI Frontier 100 ETF [FM] had a 1.1% weighting towards Sri Lankan stocks at the end of January.
Analysts are generally bullish on TSMC, with 26 out of 34 analysts polled by CNN Money rating the stock a buy. Six of the remainder rated TSMC outperform, with one apiece rating it hold and sell. The median 12-month price forecast among seven analysts was $148.25, with a high target price of $200. This likely bodes well for the emerging markets ETFs holding the stock.
The 16 analysts offering 12-month price forecasts for Gazprom yield a median target of $7.15, which was 19.6% higher than its 11 February close. Of the 16 analysts polled, 13 rated the stock a buy, with one recommending outperform and two suggesting to hold.
Meanwhile, the consensus among 22 analysts was a buy for Vale SA, with 19 recommending this rating, two a hold and one an underperform. The median price target among 21 analyst offering 12-month forecasts was $20, which would represent a 15.14% increase from its 10 February close.
Despite the overall positive sentiment for these key emerging market holdings, there are some calls for caution from the analyst community. David Hauner, emerging market strategist and economist at Bank of America Securities, cautioned that rising US interest rates and a strengthening dollar at the start of 2021 could both be warning signs for emerging markets.
“Most EMs are fundamentally solid enough to deal with moderately rising rates,” he wrote in a note, seen by the Financial Times. “Still, returns in EM fixed income this year are likely to be just moderate.”