Investing — the great escape WHEN the world’s biggest fund manager reverses its view on half of the global economy it is time to take notice. That is what BlackRock, manager of $4.6tn for investors and savers, has done this year. Once negative on emerging markets, it has turned into a cheerleader for them.
Sergio Trigo Paz, BlackRock’s head of emerging market fixed income portfolio management, now talks of a ‘great migration’ — a mass movement of big institutional investors away from the stagnant growth and negative interest rates of the developed world, to the resurgent economies and enticing yields of emerging markets.
“This is not just the tactical guys,” he says. “This is pension funds, sovereign wealth funds. The big, big guys are starting to move.”
Flows to emerging market bond mutual funds — a small but significant part of the investment universe, and one of the few sources of real-time investment data — tell a dramatic tale. After a bout of panic over China at the start of 2016, investor sentiment warmed to the sector in the following months, and surged into emerging market bonds in July.
But it is far from clear that this signals a fundamental change of fortune for the real economies of emerging markets. They account for 52pc of global economic output calculated in terms of purchasing power parity and 38pc in nominal terms, so the answer to the question is of huge significance for the global economy. If they really are taking a turn for the better, it could offer a new locomotive of growth for a sickly world.
The latest growth forecasts from the International Monetary Fund offer some optimism. It expects the pace of gross domestic product growth in emerging markets to increase every year for the next five years while developed markets stagnate.
Investors who traditionally have avoided emerging markets are now part of a mass ‘migration’ of funds into the sector. But the switch has less to do with potential growth in Brazil or Vietnam and more to do with stagnation at home
But in truth emerging markets are growing from a shrunken base and a big part of the upturn is not due to things getting better but to things no longer getting worse. Big economies such as Russia and Brazil, for example, in deep recession for the past two years, are finally heading back to growth.
“Last year, it was all doom and gloom,” says Peter Kinsella, head of EM research at Commerzbank. “But EM as a whole is about to post its strongest GDP growth in four years.”
There are parts of the emerging world showing genuine signs of economic strength, including Poland and the Czech Republic in eastern Europe, Mexico in Latin America, and large parts of Asia — Vietnam, the Philippines, India, Sri Lanka, Bangladesh, even Pakistan. This can be traced in part to governments having put public finances in better order and some, notably Mexico and India, embarking on ambitious reform programmes.
However, even though these pockets of optimism are real, the massive flows into emerging market debt and equities should not be taken as a sign of the start of another breakout period for these economies, say analysts. The flows are as much an escape from low yields in developed markets as they are a sign of faith in their emerging counterparts.
Big questions still hang over the asset class, in the shape of the US Federal Reserve’s monetary policy, China’s inexorably rising mountain of debt, and the still fruitless search of emerging economies for a growth model to replace the commodity and credit-driven booms of the first dozen years of this century.
“Fund flows to EMs have gone through the roof,” says Mr Kinsella. “But this is best described as [the result of] push factors rather than pull factors.” Those push factors have become immensely powerful.
“The old-school thinking was that emerging markets had a lot of growth but lots of risk and that safety was in places like the UK,” says Anthony Cragg, a senior portfolio manager at Wells Fargo Asset Management. “The events of the past few weeks [following the UK’s vote to leave the EU] have made people rethink that whole notion.”
It is not only the UK’s leap into the political unknown driving such a re-evaluation. Elections in the US, France and Germany over the next 12 months and repeated terrorist attacks have made the developed world look a lot less safe.
Developed markets have also become much less dependable as a source of growth and investment returns, especially for US public sector pension fund managers who must somehow try to secure returns of 7-8pc a year. The ultra-loose monetary policies of recent years have mostly failed to deliver a return to economic growth in the developed world. The same policies now mean that more than 30pc of global government bonds are trading at negative nominal yields, and a once-reliable source of returns for would-be retirees, and many others, has run dry.
Until this year, nobody would have taken seriously the idea that emerging markets could make up the shortfall in economic growth. As the IMF figures show, aggregate GDP growth in emerging markets has fallen every year since 2010, while the developed world has spent the past three years in post-crisis recovery.
That this is now changing marks a big shift in the dynamics of global growth. However, Ruchir Sharma, head of EM equities and chief global strategist at Morgan Stanley Investment Management, says investors in emerging markets are less concerned about whether these economies are growing more quickly than those in the developed world. Rather what excites them is whether the differential between GDP growth in the two is actually increasing.
“EM has been growing faster than DM for the past five years and yet EM has underperformed because the differential has been collapsing,” he says. “This year the differential has stopped collapsing. It has stabilised.
“This is the single best predictor of performance for equity markets.”
But he dismisses any suggestion that this heralds a return to the glory days of the 2000s, when emerging markets consistently outperformed those in the developed world by a wide margin and foreign capital flooded in.
In 2007 — the peak of the boom for emerging markets — there were 60 economies in the world that were growing annually at a pace of more than 7pc, Mr Sharma notes. “Today, that number is down to eight or nine countries,” he says. “The baseline for success is changing everywhere.”
Even if they are wary of China, other asset managers say there are growth stories to be found in other parts of Asia, in eastern Europe and Latin America. BlackRock’s Mr Trigo Paz, who changed his view on EM bonds in February, describes what is happening now as a ‘capitulation’ — a realisation by big institutions that they can no longer afford to ignore the returns on offer in emerging markets, which have been as high as 13pc in the year to date.
For investors keen to earn the returns on offer, says Mr Trigo Paz, “the fundamental rationale box has been ticked”.