For long-term investors, the argument for buying into emerging markets funds is simple and persuasive. Booming economic growth in China, India and Brazil will continue to boost corporate profits and share prices across all sectors.
But even among the bulls, the consensus is that the attractions of Asia and Latin America are not quite as exciting in the near-term. Some even believe that emerging markets are already over-valued and due for a correction.
In China, for example, A-shares listed on the Shenzhen index trade on more than 31 times forward earnings. In India, shares trade on an average of 16.8 times earnings. So, to some analysts, both look vulnerable.
Rupert Robinson, chief executive of Schroders Private Bank says: “Emerging markets have become over-loved, over-owned and too fashionable. Long-term, we are bullish. Near-term, however – especially, if you have new money – we would wait for a better time to buy.”
Justin Modray, founder of advisory firm Candidmoney.com, echoes this view, arguing that a dip in asset prices would make emerging market funds more attractive to new investors.
“The recent upturn in
global markets leaves
little room for making a quick buck over the next year or two unless the imminent global slowdown is less fierce than expected,” he says.
Even so, spiralling debt levels and poor growth rates in Europe and the US make the larger emerging economies look more attractive, in relative terms. As a result, UK investors have rushed to buy into the sector, pumping £1.6bn into emerging markets funds in the past year alone.
Looking at past investment performance, it is easy to see why. Over five years, the difference in the returns from UK and emerging market equities has been pronounced: the FTSE Emerging Markets index was up 90.2 per cent in the five years to this month, while the FTSE 100 gained just 3.3 per cent.
In the coming months, however, risks are set to emerge.
Inflated equity valuations in some parts of the developing world are cause for concern. “The key is whether these markets can grow
sufficiently to merit this premium,” says Modray.
Some markets still look cheap, though. In Brazil, shares trade on an average of just 10.9 times forward earnings in spite of an 8
per cent economic growth forecast; and in Korea shares trade on 10.8 times earnings.
Rising inflation might also hit emerging markets. Another round of quantitative easing in the US – buying up government bonds to pump money back into the economy – is likely to boost commodity prices as “real” assets return to favour. Inflows into these safe-haven investments, in turn, would push up inflation across Asia.
China, meanwhile, faces its own hurdles, in part due to the tightening of monetary policy by the country’s central bank and its currency battles with the US.
In addition, its property market looks to have peaked, with prices being supported by speculators, according to analysts.
Any collapse in housing demand or construction activity might have disastrous effects on China’s stock markets, advisers warn. “There is a danger that investors have been complacent about the rising interest-rate environment in China,” says one.
Even so, some investment advisers still believe emerging markets will outperform western markets in 2011, as higher-growth economies continue to attract investment inflows.
“As the US and Europe wrestle with budget deficits and sluggish economies, emerging countries are enjoying high-quality and sustainable growth, supported by their young and expanding populations,” concludes Dean Newman, head of emerging markets with Invesco Perpetual.
“If the global growth picture was to deteriorate, we believe that emerging countries are now in a far more favourable and flexible position to respond to a change in economic conditions.”
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