Q&A: emerging markets
At the start of September, Moneywise hosted a live webchat with two investment experts - Michael Konstantinov, fund manager of Allianz RCM BRIC Stars Fund, and Darius McDermott, managing director of Chelsea Financial Services – to find out what the future holds for the emerging markets.
The BRIC countries of Brazil, Russia, India and China are steadily increasing their global economic presence. As these economies move out of the shadows, there is talk of a future where the United States no longer leads the world’s economy. But what does this mean for investors? Should they join the BRIC success story, and do the benefits of investing in emerging markets outweigh the risks?
Here are the best of your questions and the answers
Q: Which of the BRIC countries do you feel has the most opportunity at the moment and why?
Darius McDermott (DM): The first thing I would say is that the BRIC markets are among the biggest emerging markets and make up the biggest part of the emerging market universe. In general I would say the BRIC funds are slightly higher risk as general emerging market funds have more diversification.
Michael Konstantinov (MK): Brazil, Russia, India and China represent four of the largest domestic economies and therefore have been less affected by the global economic slowdown and have already started to recover. Therefore an investment in BRIC is an investment in the highest growth areas in emerging markets.
Q: I want to know more on the different strategies an investor could use to invest in the emerging markets.
DM: Emerging markets have doubled over approximately the last 10 years as a percentage of the world market. This leads me to believe that people should be investing approximately double the allocation they would have previously given. Another key point is BRIC markets can be quite volatile and a sensible way of investing is via monthly savings, which give you ‘pound cost averaging’.
Q: Could you discuss some ways of investing in the BRICs - are ETFs the best way or why would actively managed funds be better?
MK: The fast development in the BRIC markets results in many new company listings and as an active manager we can take advantage of new investment opportunities, which tend not to be reflected in the ETFs.
Q: Today many people fear what could happen when eventually governmental support will be cut off. The recent rapid recovery on the stockmarkets could just be a bubble. But how is the situation in the emerging countries? Is the recovery based on governmental support or is there a good foundation for the rapid recovery? If a double dip recession follows, will they be able to resist?
MK: China today sells more cars than the US. This is one example of how important domestic demand in the BRIC economies has already become. This dynamic has helped the BRIC economies to come out of this global slowdown faster than the US or Europe and is providing an important foundation for future growth. Therefore, I believe that the growth outlook will be very positive even if the developed markets continue to suffer.
DM: I believe that globally - not just in emerging markets - that government stimulus packages have helped markets recover. The BRIC markets have risen more than mature (i.e. Western) markets and the sharp rise in these markets should be noted.
Q: Can I put BRIC funds within an ISA or other tax efficient wrapper?
DM: Yes - BRIC funds absolutely qualify for ISA investments.
Q: If everyone piles into emerging markets, how can more rational investors make sensible long-term choices?
DM: The key to this is the length of time people want to invest – if you are looking to make a quick profit in the next six months, the sharp rise in BRIC markets should be taken into account. That said, I think now is an excellent entry point for long-term investors (i.e. a minimum of five years) to invest in high growth markets like the BRIC markets.
MK: BRIC markets represent 40% of the world population with a growing affluence. The new consumer class will become the new driver of the world economy. It is expected the BRIC markets will be among the five largest economies in the world and therefore a BRIC investment can participate in this long-term growth.
Q: Given that the tracker I had in India fell something like 10% in one morning during the credit crunch I am somewhat sceptical about further investing in emerging economies. How should I balance the risk here?
DM: Investing in the BRIC markets, for me, is some of the riskiest areas you can invest in. You need to be aware that there could be currency, geopolitical, and corporate governance risks and hence investment in BRIC is not suitable for those with lower risk 'tolerances'. On the other hand, of course, the higher risk in this area could potentially lead to much higher returns.
MK: The recent sell-off was initiated by the financial crisis in the US. The encouraging thing is that BRIC economies and equity markets have started to recover quickly because the negative impact has been not as strong as expected. I believe that you should find there is less volatility in the coming years.
Q: Does a weak economy in the West lead to more trade or less trade with BRIC countries?
MK: I think that recent trends show that trade within the BRIC countries is increasingly important - and starting to replace part of the lost trade with Western countries. Over time this should lead to less dependence on the West.
Q: The emerging markets have gone up very fast in the last few months. Is this growth justified or is a bubble being created around emerging markets? Is a correction going to take place? Will these markets know more growth in the second half of the year?
DM: The BRIC markets have the strongest GDP growths particularly compared to the more mature Western markets. GDP forecasts of 8.8% for China and 7.2% for India in 2010 are way in excess of growth rates expected in Western economies.
Referring to my earlier answer – the fact that the markets have risen so sharply since March - does need taking into account depending on your investment time horizon. Another factor in the strong rise since March was the fact that these markets were heavily oversold in the previous 12 months.
MK: If you look at current variations in the BRIC markets, they are in the middle of the historical valuation range with an expected earnings growth of 20% to 25% for next year. I believe a BRIC investment still offers attractive rewards.
Q: What do you think about separate country funds vs. a combined one?
DM: Separate country funds are a higher risk than a BRIC fund because with these you get greater diversification with the four markets. China has the strongest forecast GDP growth. Russia is the cheapest on valuations. India is going to have the biggest population growth and thus the greatest proportion of middle-class consumers. Brazil will supply a lot of the materials for the growth in those other countries.
There will be periods of time where a single country fund will out-perform a BRIC fund but investing long-term in BRIC funds offers a simple way of getting access to all these high-growth markets.
Q: Can we still include Russia in the BRICs? And, will Russia recover as fast as the others?
MK: I am a clear believer in the ‘commodities supercycle’, which is a result of the limited commodity supply and the commodity intensive industrialisation of the BRIC markets. For instance, the BRIC countries are demanding more energy, copper, oil, iron ore etc. This strong demand for commodities will result in higher commodity prices for longer and one of the prime beneficiaries of this trend will be Russia, because Russia is the second largest oil producer in the world. As the Russian equity market is strongly correlated to commodity and energy prices, the prospect is closely related to the BRIC story.
Q: To what extent are the BRIC markets vulnerable to political instability? They all seem to have fragilities in one way or another. Is this something I need to worry about?
MK: These concerns contribute to the fact that, yes, these are high-risk investments. If you are uncomfortable about the risk then you should perhaps not invest in these areas.
Q: Am I damaging the economy in the UK by investing my money elsewhere?
DM: It's a good question and I would answer by saying that the biggest 100 UK companies - the FTSE 100 - generate 60% of their earnings overseas so I do not feel that investing overseas is damaging to the UK.
Q: How do you see BRIC markets evolving in the next five years?
MK: I am expecting similar growth rates for the BRIC markets to the ones we have seen in the previous years. This growth path is driven by the growing affluence of the middle classes and will be driving the earnings growth of the BRIC countries’ listed companies. On the back of that I expect markets to appreciate in accordance with 20% annual earnings growth
The total money value of all the finished goods and services produced in an economy in one year. It includes all consumer and government consumption, government spending and borrowing, investments and exports (minus imports) and is taken as a guide to a nation’s economic health and financial well being. However, some economists feel GDP is inaccurate because it fails to measure the changes in a nation's standard of living, unpaid labour, savings and inflationary price changes (such as housing booms and stockmarket increases).
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
A catch-all phrase that can range from assessing the price of a property or vehicle before offering it for sale or the net worth of assets in an investment portfolio to the prices of shares on a stock exchange.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.
An Exchange traded fund is a security that tracks an index or commodity but is traded in the same way as a share on an exchange. ETFs allow investors the convenience of purchasing a broad basket of securities in a single transaction, essentially offering the convenience of a stock with the diversification offered by a pooled fund, such as a unit trust. Investors buying an ETF are basically investing in the performance of an underlying bundle of securities, usually those representing a particular index or sector. They have no front or back-end fees but, because they trade as shares, each ETF purchase will be charged a brokerage commission.
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
An acronym, which stands for Brazil, Russia, India and China; countries all deemed to be at a similar stage of advanced economic development. The term was coined in 2001 in a report written by Goldman Sachs director Jim O’Neill who speculated that, by 2050, these four economies would be wealthier than most of the current major G7 economic powers.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.