Emerging market economies have traditionally experienced cyclical ups and downs but are now starting to show signs of becoming more structurally sound, creating new opportunities for investors, says Alan Dorsey, head of investment strategy and risk at Neuberger Berman.
“As we start 2013, it is becoming possible that the historical pattern for emerging markets is entering a new phase.
“Historically emerging markets have been highly vulnerable to cyclical issues that tend to create economic highs and lows not necessarily correlated to structural stability or financial realities, but this is now starting to change.
“There are a number of reasons for this but the result is that there are now more grounds to think this time is different and that emerging markets are migrating to become more traditional, core asset classes.
“This represents a one-time transformation of emerging market equities and debt that could provide a unique opportunity for investors, who generally speaking are underweight emerging market asset classes.
“The basic strength of many countries in Asia, Latin America and Eastern Europe has rarely been so secularly robust as it is now, particularly in comparison to many developed countries.
“In my view, the final ‘hurdle’ to becoming a permanent part of investor portfolios would be for emerging market economies to put in place more consistent governance practices and, in those countries where it is still a problem, reduce fraud and corruption,” he said.
Mr Dorsey said that there are several key factors driving the shift from cyclical to structural macroeconomics in emerging markets, including: GDP growth; foreign exchange reserve accumulation; current account surpluses; a growing middle class; robust fiscal and monetary policies; and the stability of local institutions such as sovereign wealth funds and pension funds that are investing in projects in their home regions such as infrastructure.
“The main implication of these drivers is that there is a structural reduction of risk in emerging market economies, not least through emerging market debt being upgraded to investment grade.
“While risk hasn’t been eliminated entirely, we are seeing a situation where the risk levels of emerging markets are, in many cases, lower than they have been in the past, and potentially lower than those of many developed markets.
“For example, the growth in exports in emerging economies has allowed them to substantially increase their currency reserves at a much faster rate than developed countries.
“This gives emerging economies more scope to support domestic currencies and avoid currency dislocation in the event of crisis, an issue that emerging markets have been vulnerable to in the past,” Mr Dorsey said.
The growing middle class is another key factor in supporting stability in emerging markets.
“Historically, $5,000 in annual disposable household income is the point of critical mass, when domestic consumption starts to grow strongly.
“In China, India and Indonesia in particular, the number of households with an annual income between $5,000 and $15,000 has grown rapidly over the last decade, and is predicted to increase further over the next ten years.
“In China, for example, less than 20 million households had an income in this range in 2000 but in 2010 there were almost 125 million households and by 2020 it is expected that almost 200 million households will earn between $5,000 and $15,000 a year.
“As the purchasing power of the middle classes grows, the local economy tends to transition from being primarily dependent on exports to developed countries, to having more balanced growth driven by domestic consumption and investment in local infrastructure.
“Such investment is critical as it helps to improve efficiency, increase capacity and potentially mitigate inflationary pressures.
“Furthermore, trade between emerging economies has grown and diversified, reducing their reliance on the Western world and potential exposure to the economic malaise affecting Europe and the US.
“On top of these trends, we can see reduced inflation in emerging economies that has helped contribute to economic and financial health and stability.
“All these factors are creating a situation where emerging markets are economically more robust and healthy, and less vulnerable to the kinds of downturns or problems that plagued many in the past.
“Investors still need to weigh the risk and return carefully but, particularly when compared to the developed world, emerging markets are an increasingly attractive investment option and investors who take advantage of this now are well-placed to benefit from the ongoing growth and strength of the market,” Mr Dorsey said.
Neuberger Berman was established in 1939 and is a US-based asset management company with approximately US$203 billion in funds under management throughout the world (as at 30 September 2012) and over 1,700 asset management professionals. It is one of the world’s largest independent, employee-controlled financial services organisations.
The company offers a number of funds in a range of asset classes including global and emerging market equities, bonds, and alternatives such as hedge funds and private equity.
Neuberger Berman Australia gained a licence to operate in Australia in April 2011.
15 January 2013