Emerging Markets Provide Cheap Income

Emerging markets may be volatile but in the search for diversified income, investors must be prepared to take a bit of capital risk for the reward of dividends

Emma Wall 10 July, 2014 | 12:29PM
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Emerging markets have face several macro-economic challenges this year, making investment in the region hard to predict and even harder to profit from.

The ‘taper tantrum’ in the summer of 2013 saw emerging market indices lose significant value. Following the announcement from Ben Bernanke that the Federal Reserve would be tapering its quantitative easing programme, prospects for the emerging region plummeted. Having been driven upwards by the flow of cheap cash, markets pre-empted the tapering, concluding that without the liquidity afforded by international investment, they would falter.

A year on from Bernanke’s announcement and there are fresh challenges for emerging markets. While only those highly leveraged countries with weak currencies – known as the Fragile Five – were fundamentally damaged by the tapering programme, far more markets face volatility because of political uncertainty.

In 2014, 28% of emerging markets will hold elections. This is the largest proportion of elections held by this group of countries in more than a decade. Many of these may prove to be positive for the economies in which they are being held – but outcomes are hard to predict, and groups’ political policies range far more widely than in the developed world.

The recent election of Narendra Modi in India was unexpected. Following the elections in April, Modi has led the first single party majority win in Indian politics in 30 years. Prior to Modi’s election bringing about reform in India was a complicated and inefficient process – a case of too many cooks spoiling the broth. Today the new finance minister Arun Jaitley will deliver his first budget, and little has leaked to the press on what measures are likely to be announced.

Avinash Vazirani, manager of the Bronze Rated Jupiter India fund said he had expectations on what he would like to see in the budget.

“Progress on introducing a general sales tax, streamlining land acquisition policy, labour law reforms, a reduction in subsidies and the introduction of real estate investment vehicles or REITs to name but a few, but like any wish list, it is unwise to hope they will all come true.”

Adrian Ash, head of research at BullionVault.com, said that any easing in India’s anti-import rules might be expected to boost gold prices.

“India is the number one gold-buying nation, and India’s gold demand reacts to price moves,” he said.

Whatever happens today, the unity in India afforded by a single majority political party is regarded by most to be positive for the market and the economy.

The elections in Indonesia – which took place this week – and those in Brazil – which are scheduled for October, could have significantly different effects on the economy and the stock market dependent on who is elected.

Craig Botham, emerging markets economist at Schroders said it was difficult to be overly optimistic about the Indonesian elections.

“The market’s favourite, Jokowi, has seen a deterioration in his opinion poll lead which has forced him to align his policy stance more closely to Prabowo’s, hinting at barriers to foreign investment to protect domestic firms,” he said. “We can hope this nationalism is not genuine, but it is not a promising sign.”

The candidates in the Brazilian election have a similar disparate stance when it comes to market reforms.

BlackRock Latin American (BRLA) fund manager Will Landers says investing in the region was all about the politics at the moment.

“We are hoping for an opposition win in Brazil, any change is positive at this point. After three years of unnecessary government intervention has resulted in low GDP and a stagnant corporate sector. The current government is not positive for the economy,” he said.

Despite these political uncertainties, investors searching for income would be foolish to ignore emerging markets. Income assets have become increasingly correlated – and expensive – as low interest rates in the developed world have forced investors to take to the markets in their yearning for yield.

Dividend paying equities in the UK, Europe and the US are trading above their long-term average valuations – but emerging markets are on a 20% discount to long-term valuations.

Put simply – as JP Morgan economist Andrew Goldberg said: “They yield and are dirt cheap.”

Pau Morilla-Giner, chief investment officer at London & Capital agrees that now is a good entry point for emerging market equities.

“We are now seeing signs that this picture may be abating and we may have finally reached the bottom compared to the historical valuations,” he said.

“Emerging market equities price multiples indicate that the asset class is now extremely cheap not only on a historical basis but also when compared against developed equity markets. For investors, especially global asset allocators, these lower valuations provide a cushion for disappointment, especially at a time when many other asset class valuations are stretched.”

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
BlackRock Latin American Ord369.34 GBP-4.56Rating
Jupiter India L Acc143.89 GBP0.15Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar