Wealth managers’ ongoing incursions into emerging equity markets appear to have resulted in the annexation of a new super state. Forget the Brics. Last month, BlackRock built a case for the breakaway republic of “Chindia”. And in the search for growth, it’s not the only investment firm redrawing the map.
Merrill Lynch Global Wealth Management now considers China a “must have” for its equity portfolios, and India an “economic giant” with an equally resilient equity market. Fund manager Apollo Multi Asset Management now recognises “divides between the likes of China, India etc” and more indebted emerging economies. Even those adopting a passive foreign policy appear in thrall to these nascent powers: second quarter net inflows into Lyxor’s emerging market exchange traded funds (ETFs) were up 200 per cent on the previous quarter, to $900m (£564m), with Lyxor ETF China Enterprise and Lyxor ETF MSCI India the most popular single-country funds.
It is a quasi-unification being driven by a shared belief: rapid growth in China and India’s gross domestic product must deliver higher equity returns than developed markets. “China and India are two of the most formidable emerging economies,” BlackRock argues. “China has been recognised as the next world superpower for a number of years … India is the fourth largest nation in world GDP and the world’s second fastest growing economy.”
Even though China’s growth has historically been driven by cheap exports to the developed world – and will require a new driving force to sustain it through a global downturn – BlackRock believes domestic consumption and an increase in productivity can provide this force. India’s GDP growth has also slowed, but is still estimated at 6.7 per cent in 2008-09.
With the governments of the two powers showing a willingness to intervene to prevent economic overheating, Bill O’Neill, portfolio strategist at Merrill Lynch Global Wealth Management, has become a long-term supporter. “As an engine of economic activity [China] is dominant among the emerging markets and is the source of incremental growth for the developed world, too,” he says. “Progress … will depend on how the Chinese government manages access to credit, but there is evidence it understands the dangers of stop-go stimulus policies.”
He sees a similar understanding in India. “Policymakers are determined to tackle any monsoon-induced rise in inflation spreading into general price levels,” he claims.
Investment managers at Apollo regard this breakaway as a “new decoupling” – not of emerging markets from the west, but of China and India from emerging eastern Europe and Latin America. Steve Brann says: “We will see divides between the likes of China, Brazil [and] India versus the likes of Romania, Latvia, Mexico and other indebted emerging economies.”
However, before allowing their portfolio allocations to cross into Chindia, clients may want to consider the latest research from Paul Marson. He’s the former Bank of England economist and chief investment officer for Goldman Sachs Wealth Management, who now works for the Swiss private bank Lombard Odier.
Marson has called into question the investment boundaries being drawn around China, India and other emerging economies. In a statistical analysis of emerging market GDP and stock market performance from 1976 to 2005, he has found no correlation between economic growth and equity total returns, or between economic growth and earnings per share growth.
Marson attributes this to two factors: corporate financing and equity valuations. emerging market companies financing their expansion from internally retained funds benefit themselves, rather than shareholders – and those companies financing expansion from externally gained funds must, by definition, dilute their shareholders. So if external investors are to make any profit, they have to buy in early, on low valuations – which wealth managers seem reluctant to do.
“Faster-growing economies do not produce better returns than slower-growing economies,” he says. “The key to returns is current valuation. Worry about where you are starting from, not what you hope will happen. The ship’s captain setting off from Europe won’t attempt to predict the weather when he reaches Cape Horn, but he will be prepared for the likely weather patterns experienced there at this time of year.” Explorers on a fast boat to Chindia would do well to remember that.