16th June 2014
In this Q&A, Devan, whose team runs the Elite rated Aberdeen Latin American Equity fund, talks to FundCalibre about recent emerging market woes, and whether the outlook for the asset class has improved.
Devan Kaloo, Head of Global Emerging Markets, Aberdeen Asset Management
Why have emerging markets struggled in the past few years?
In my opinion, the single biggest reason for the poor performance of emerging markets in the past three years has been the decline in corporate profitability. The developed world has been very good at maintaining earnings while growth has slowed, as companies have been cutting costs. Emerging market companies haven't done this – they thought that slowing growth was going to be a short-term blip and instead continued to invest. So as growth has slowed, earnings have reduced.
Another major issue has been slowing growth in China, the biggest market in the asset class and therefore the one with the most influence. There has been a misallocation of capital in China for many years and the government has been spending more and more whilst the economy has grown less and less. The government is now trying to change that and move the economy from one reliant on state investment to one that is more driven by domestic spending. In the long term this move is very positive for markets, but in the short term it can, and has, caused a lot of problems.
A knock-on effect of all this has been that money has been coming out of the asset class, as investors have been tempted elsewhere. Last year alone, $28 billion was reallocated away from emerging markets. The latter was, in part, a reaction to the US starting to slow its quantitative easing measures, or 'tapering' as it is called. The effect of tapering has been that the cost of capital in emerging markets has increased (as the US dollar has become stronger) and current account deficits have become more difficult to finance. So emerging markets have had to increase interest rates, which, in turn, has had a direct impact on growth. Those emerging market economies with the biggest current account deficits have suffered the most.
What is the outlook for the asset class? More of the same or do you think it has improved?
Emerging market companies were growing too fast before the financial crisis – at an unsustainable rate. The global economic slowdown has obviously tempered this; emerging market currencies have devalued and interest rates have increased to give currencies some much needed support. Imports have, as a consequence, declined. However, current accounts have now started to improve and we are now in a position where interest rates could start to come down and growth could start to pick up again. 2015 could be a very good year for emerging market earnings and valuations are very cheap compared with 5-10 year averages. Economies that suffered the most, due to large current account deficits, have been forced to change and some companies in these countries are now looking extremely attractive.
I would say things could improve this year, and they have to some extent, as the market is up around 5% year to date, but there are about 15 elections in emerging markets in 2014 so governments are concentrating on getting re-elected rather than economic reforms. So next year it is.
You mentioned China earlier. What are your thoughts on this market?
We've been underweight China for about 14 years, but I think the time when we actually move overweight the market is closer than it has ever been before. I don't think there will be a banking crisis as they don't rely on overseas lenders, and the government is unlikely to let a bad bank go bust. The government owns part of most banks, so they will simply recapitalise instead, if necessary. Growth will continue to slow but it won't collapse. All in all, it is looking more positive.
What about Latin America?
Latin America has been one of the better performing regions recently. The Brazilian market has improved as the popularity of the government has declined - this government has interfered in companies and had a negative impact. It has the opposite problem to China – the economy has been too reliant on domestic spending and infrastructure development has been lacking. There is an election this year and a change in leadership could be good for the market.
What changes have you made to the fund recently?
We've been adding to Russia, reducing our overall underweight to the market. We've also added to Turkey, Indonesia, Thailand and Brazil. We are still overweight India.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Devan's views are his own and do not constitute financial advice.