Emerging markets are emerging from the crisis

BRIC and emerging marketplaces have suffered from the financial crisis; but there are now signs once again that they offer real opportunities.

 In the run up to the ongoing financial crisis and during its initial unfolding, many emerging markets showed such a surprising degree of resilience that there was considerable talk that they had decoupled from the mature markets. But this perception was soon shown to be false as the crisis took hold. Now though, with risk appetite seemingly on the increase, the emerging, or perhaps more accurately the alternative markets, are once again offering new investment opportunities to a broad range of investors.

As Matthew Clay, senior research analyst at IDC Financial Insights pointed out there has been plenty of talk about a flight to quality and a desire by investors to seek less complexity. But the fact is that emerging markets have strongly outperformed in 2009. At the end of September, the FTSE 100 stood 16.35% higher than it had done at the start of 2009; similarly, the S&P 500 had risen by 18.64%. In contrast, the MSCI Bara Emerging Market Index had soared by 62.7%.

“I think it’s true to say that after the credit crisis there was a flight to quality. You saw emerging market funds closing up or moving to less risky sets. But now that we are emerging from various recessions, people will want to see greater returns,” said Howard Snell, an emerging market veteran and director of Otkritie Securities, a large Russian broker and provider of direct market access (DMA) to the country.

According to Snell, investors are likely to come to the conclusion that blue chip investments in major markets may soon not offer sufficient returns to entice them. “Emerging markets still have a long way to go. If you look at the FTSE and the Dow, they went down but the FTSE is almost back to where it was. Whereas, the RTS and MSCI Index aren’t even at 50% of where they were…so there is still plenty of opportunity in emerging markets. Price/earnings are much better than in a mature market. In Russia, it’s the lowest you can get at just over seven, against an emerging market average of 12,” he argued.

Milan Procházka, head of capital markets at Prague-based Wood & Company, which runs membership on nine exchanges in Eastern Europe and Dubai, contended that the emerging markets had effectively been ‘over punished’. “It was not the emerging markets which triggered the fall out, unlike Russia in 1997 or Mexico and Argentina on other occasions. Still, the biggest hit was on Russian equities and bonds. There was no safe harbour in the emerging world – if anything had emerging in its name, it was like a stigma.”

However, there are real signs that things are turning around. “I think though that going forwards, I’m a big believer in the emerging markets…We are now seeing these markets being very efficient and high growth. The population in these markets is very young and adaptable,” he continued.

And meeting the needs of those populations will potentially be another growth factor for the emerging markets. Cathy Lyall, an independent consultant working for Brazil’s BM&FBovespa, used some statistics to highlight the attraction of the country. Not only is it huge – Brazil is the fifth largest country in the world – it has a large educated population, a strong agrarian economy and an extremely attractive tax regime. “BM&FBovespa is actually the second largest exchange in the Americas, right behind the CME Group. It’s the fourth largest in the world on market cap…which a lot of people don’t realise,” Lyall pointed out.

As importantly, Brazil is seeking to make itself an attractive location for investment. It has overhauled its trading systems and is overhauling its banking and regulatory regimes. This is something that is also happening elsewhere. “What is important for people going into emerging markets is the regulatory backing and transparency. For Eastern Europe, all these countries are members of the European Union and are adopting MiFID. There rules are similar to those in Germany, France and the UK…you do have investor protection, but when things start moving things can still fall off the edge of a cliff,” said Procházka.

Snell agreed that pitfalls do remain. “I wouldn’t go as far to say they’re (emerging markets) safe havens, because there hasn’t been a decoupling from the mature markets. If we see a massive fall in the mature markets, the emerging markets are going to fall as well. Where there is a relative ability for them to be safe havens is by picking the right stocks in the right markets,” he said.

Another factor was that strength in the domestic economy naturally stimulated stability and lessened the impact of speculative or fickle investors. “The sway of hedge funds will diminish, because the populations of the countries will be much more involved in their stock markets. Russia is a case in point; people don’t have pensions, but they are starting to build them through personal investment funds,” Snell reasoned.

The financial crisis has presented an opportunity to bring global rules and regulations more closely together. If regulatory standardisation is achieved, it will boost confidence in investing in emerging markets. “I think we’re a long way from there (standardisation) yet, but you are seeing more unanimity between governments, regulators and central banks about how they are going to go forward,” said Snell.

Another change is that investment on a broad basis along the lines of, “China is booming, let’s buy it’” may no longer work. “You can’t just blanket invest anymore…now it’s much more about picking the right stocks at the right time,” argued Snell, just as it is in ‘traditional investing’.

In other words, investors should do their own research, but as they do that, they may come to rely on local expertise. “Understanding of how the individual markets work is key. Every market behaves in a different manner. I think you need local partners or brokers to help you out,” concluded Procházka.