4 minute read

Our emerging markets and multi-strategy teams set out key trade ideas over a two to three year investment horizon in the EM universe.

Valuations of emerging market (EM) currencies, equities and bonds look attractive relative to developed markets, but selectivity is key in markets which are diverse and where risk and returns tend to be dispersed.


Earnings expectations for companies listed in emerging markets have recently taken a turn for the better. Earnings growth is expected to accelerate across many EM countries in 2017, including South Korea, Taiwan, China, Brazil and South Africa, but we believe that many stocks are fundamentally undervalued.

Figure 1: EM equities trade at a discount to MSCI World

Price-to-book discount   

On a price-to-book basis, EM stocks have been around 30% cheaper than developed market (DM) stocks since 2014, illustrated in Figure 1.[1] Recently, earnings expectations have lifted from a low base, faster than in DM, yet the EM valuation discount persists. Over the past six months, for instance, EM earnings expectations have increased by 12.5%, compared with 7.0% in DM [2]. Return-on-equity is marginally higher too, yet developed markets have outperformed.

Drilling down into the detail on the same basis also reveals that EM smaller companies are cheap relative to the wider EM universe, and have been so throughout the past decade. Smaller companies tend to be less volatile than the broad EM index [3]; their comparatively high level of domestic ownership makes them less vulnerable to changes in sentiment triggered by events elsewhere. Their orientation -- with exposure to sectors that benefit from rapid income growth (domestic retailers, industrials, healthcare) -- makes them an attractive way to access any pickup in EM momentum.

In 2017, the relative cheapness of EM smaller companies reflects the fact that earnings expectations have not rebuilt as rapidly as they have in more cyclical areas, such as commodities or financials (although small cap earnings did not decline as rapidly either.) Bearing in mind the potential for earnings upgrades, firstly as part of an industrial renaissance and then more broadly, over a three-year horizon we see scope for smaller listed companies to appreciate as the global economy accelerates.

Risks to the outlook include a faster-than-expected cycle of US interest rate hikes, which might precipitate further strengthening of the US dollar, and a potential hard landing from China.

EMERGING MARKET DEBT: Long local currency Indonesian government bonds

As the interest rate differentials between EM and developed markets are near the widest in a decade, there are opportunities to add carry within emerging markets; borrowing at low rates and investing in higher yielding markets. Within the debt markets, we see opportunities in local currency debt, which we believe offers better risk reward trade-offs than can be found in hard currency.

Indonesia is currently a preferred issuer. It is now one of the faster growing emerging markets, expanding over 5.0% in Q1 2017 [4]. The pace of growth is less rapid than in India (7.5% over the same period) [5]), but significantly faster than Brazil (estimated at 0.7-0.8%) [6]. President Joko Widodo and Finance Minister Sri Mulyani Indrawati, a former academic and one-time employee of the World Bank, have begun an ambitious reform agenda, aiming to widen the tax take, accelerate investment in Indonesian infrastructure, cut energy subsidies and reduce bureaucracy.

Recent bond market gains have been driven by aggressive monetary easing, with the central bank cutting Indonesia’s base lending rate by 150 basis points in 2016, and credible progress on the policy front. The ratings agency Moody’s recently changed its outlook from “stable” to “positive”, highlighting Indonesia’s improving balance of payments position, higher foreign exchange reserves, and a rising level of foreign direct investment [7].

Indonesia’s Achilles’ heel is its reliance on external sources of funding [8]. Real yields have fallen in 2017, but at around 2.9% [9] are attractive with the economic outlook improving.


Against a backdrop of slowing growth, rising unemployment and spill over from the ongoing conflict in Syria, Turkey’s shift towards more autocratic rule has affected investor confidence. Following a failed military coup in 2016, President Recep Tayyip Erdogan’s squeeze on political opposition prompted some members of the European parliament to call for Turkey’s membership talks with the EU -- which have lasted more than a decade -- to be brought to a halt [10].

In the slowdown that followed the coup, Turkish authorities took a number of measures to support growth; stimulating credit and allowing the repayment of foreign currency-denominated debt in Turkish lira at favorable exchange rates. With the president convinced of the need to keep interest rates contained, and external concern about the central bank’s independence, the low rates strategy encouraged growth to rebound to 3.5% in the final quarter of last year [11]. However, the fall in the value of the lira has contributed to inflation running well ahead of target [12].    

After a broad based sell-off of Turkish assets, we believe these challenges are now largely priced into the currency. The Turkish lira is cheap relative to its long term history, trading more than 15% below its 10-year average (Z-score or deviation from trend shown in Figure 2, below.)

Although there are unknowns surrounding the Syrian conflict -- a significant geopolitical risk running into its seventh year -- Turkey has some pillars in place to help manage the uncertainties, including a formal debt management strategy. For the moment, the economy is clearly running below potential. Long term positives include well established trade links, a large group of middle income consumers and an attractive population profile with youthful demographics.

Figure 2: Real effective exchange rates: the Turkish lira is trading below trend

Z-score: deviation from trend

EMERGING MARKET CURRENCY: Long South African rand 

South African President Jacob Zuma’s decision to remove his finance minister Pravin Gordhan and the leaders of a number of other ministries in March 2017 has been seen as a threat to South Africa’s ability to manage policy effectively. The outcome -- a near 7% drop in the value of the currency against the US dollar in just four days in the last week of March [13] -- was seen as a vote of disapproval for Zuma’s actions. However, reports suggesting that President Zuma’s own hold on power might be waning within the African National Congress party suggest that change may not be far off.[14] The official plan is that Zuma will step down from the party leadership later this year and as South African president in 2019.

Meanwhile, the economy -- a leading exporter of metals and rare earth minerals -- looks set to benefit from the synchronized upturn in the global economy. Although South Africa recently experienced credit downgrades from Standard & Poor’s and Fitch, stronger growth in the US and Europe and an uptick in commodity prices are being reflected positively in the country’s accounts.

Before Zuma’s latest reshuffle, the rand had been the best performing EM currency of 2017 versus the dollar. While there are risks to the outlook if the administration prioritizes allies over competence in key appointments, our analysis highlights the rand trading below trend, (see Figure 2), with capacity to strengthen as fundamentals improve.


[1] Comparing price-to-book ratios of the MSCI World and MSCI Emerging Markets indices. Source: Bloomberg, Aviva Investors, as of March 17, 2017

[2] IBES estimates. Source: Datastream, Aviva Investors, as of March 17, 2017

[3] 90-day rolling volatility of the MSCI Emerging Market Small Cap Index versus the MSCI Emerging Markets Index between December 31, 2010 and May 31, 2017. Source: Bloomberg, as of May 31, 2017

[4] Reuters, as of May 4, 2017

[5] Bloomberg, as of April 20, 2017

[6] Reuters, as of May 2, 2017

[7] Indonesia Ministry of Finance, as of March 31, 2017

[8] Moody's, as of February 8, 2017

[9] Nominal yield minus headline CPI. Source: Bloomberg, as of April 28, 2017

[10] Bloomberg, as of March 31, 2017

[11] Bloomberg, as of April 3, 2017

[12] Thomson Reuters, as of April 4 2017

[13] Bloomberg, as of March 30, 2017 

[14] Bloomberg, as of May 24, 2017

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