Pick of the emerging markets

The strong performance of the Brazilian stock market is encouraging investors to seek more opportunities in emerging economies. But analysts warn that some of the more popular markets already look overvalued and could be due for a correction, given the near 60 per cent rise the MSCI emerging markets index reported last year. Some advisers even suggest that China and India should be avoided.

“In both, you’re paying too high a multiple for limited earnings growth,” says Jonathan Compton, managing director with Bedlam Asset Management.

Brazil, Mexico, Indonesia, Russia and Turkey now rank higher on the list of countries to invest in, for many managers of global emerging markets funds.

Julian Thompson, head of emerging markets equities at Threadneedle, is particularly enthusiastic about the prospects for Brazil. He claims that the market, which trades at an attractive 13.7 times this year’s earnings, offers almost as many choices as India and China – and a number of Brazilian companies boast “extremely good returns on capital”. In his view, consumers will continue to drive the country’s domestic economy. So, in terms of individual shareholdings, he favours consumer goods groups such as Lojas Renner, the country’s second-biggest clothing retailer, and Anhanguera, the Brazilian education group.

Another factor is Brazil’s role as an increasingly important global trader, through the export of commodities and the acquisitions of overseas companies, points out Nicholas Morse, head of Latin American equities with Schroders. “Brazil’s GDP growth is going to be good and inflation remains low and contained,” he says. “And there’s a strong entrepreneurial spirit there.”

But even Threadneedle’s Thompson warns that the country’s upcoming presidential election in October could derail its markets, and that an expected economic growth rate of 5 to 6 per cent this year might be “too strong”.

He says: “We would like to see evidence of Central Bank tightening, so that they don’t lose control of inflation expectations.” Any appreciation in the US dollar would affect the Brazilian real, and higher interest rates could slow economic growth, he adds.

James Syme, an emerging markets specialist with Baring Asset Management, is also wary of Brazil’s attractions. “There are some significant risks and it could be a difficult year for Brazilian equity markets,” he says.

But he points out that value stocks are still available on low multiples, and that the market boasts the world’s best iron-ore company in mining group Vale SA (formerly Companhia Vale do Rio Doce).

Mexico also has its share of quality businesses, managers suggest, including Walmart de México and Petróleos Mexicanos. Overall, the Mexican equity market currently trades on 14.5 times 2010 earnings, and its performance is likely to improve as the US economy recovers, due to trading agreements.

Indonesia and Turkey both continue to report strong economic growth, according to Baring’s Syme.

And in spite of corporate governance concerns, Russian companies, particularly in the technology sector, look undervalued relative to other markets. Russia’s market trades on around 8 times this year’s earnings, according to fund managers.

“Russia generates difficult headlines, but it looks incredibly cheap on a valuation basis and there’s potential for strong earnings growth,” notes Syme.

China and India, whose equity markets trade on 35 and 28 times 2010 earnings respectively, are seeing less attention. “They are over-valued – it’s a bubble,” concludes Bedlam’s Compton.

Adrian Lowcock, senior adviser at investment firm Bestinvest, advises taking a cautious stance on emerging markets. “Long term, they have provided better returns than developed markets,” he admits. “However, considering the recovery, these areas no longer look cheap.”

But on that longer-term view, the case for investing in emerging markets remains compelling, say others.

“Much of the developed world has a balance sheet problem, particularly at the government level – how will they deal with such a debt burden?” asks Nicholas Morse, head of Latin American equities with Schroders. “So, the developing world has a clear advantage.”

Over 20 years, the MSCI emerging markets index has produced a 10.6 per cent average annualised return, outpacing the FTSE All-Share index, which returned 8 per cent.