Investors should stick with emerging markets despite China turmoil

There is a powerful consensus that emerging economies will continue to outperform the developed world for the next 35 years

Chinese dragon

By 2050 China will be the world’s largest economy Photo: Alamy

On this side of the world, we are seeing vast sums flowing into European markets, particularly fixed income. As I write, the five-year German bund is yielding a whole 0.07pc, hardly the type of return that you could build a pension pot on.

Similarly there is a huge amount of liquidity chasing European property and infrastructure investments, so much that it is hard, to be honest, for a fund manager to invest effectively or prudently.

The European Central Bank’s great quantitative easing (QE) machine is now inflating asset values across the board. I find it hard to reconcile the tales of woe in the papers every morning as the EU wrestles with Greece and the future of the euro, with this wall of money thundering into what is arguably the world’s least attractive economic region right now.

In the US meanwhile, everyone is holding their breath for what is probably the most heavily flagged rate rise in history.

On the other side of the world, Asian markets, and emerging markets as a whole, are as out of fashion as they could be.

Investors’ money has drained away from investments in Asia, Africa and Latin America month after month for the past two years – towards the perceived (wrongly perceived in my view) safe havens of Europe and the US.

This trend has accelerated in the past few months, thanks in large part to the extraordinary events on the Shanghai stock exchange.

Until about a year ago, the exchange, which is relatively immature, illiquid and largely closed to foreign investment, was trading steadily. The main Shanghai Composite index was hovering around 2,000, roughly the same level it had been at since 2012.

Then a shift in government policy, and an injection of liquidity triggered one of the most frenzied bubbles in financial history.

From November until June this year, the composite index more than doubled to a peak of over 5,100 on the back of absolutely no fundamentals whatsoever, other than the Chinese government’s desire for some of the major corporations to raise equity to pay down their debts.

Every bubble bursts however, and this bubble is deflating very rapidly despite attempts to pump it back up at regular intervals. The Chinese authorities are learning the hard way, like Western governments do on a regular basis, that they can’t control market forces, and that any attempt to do so is usually expensive and futile.

The index is back down to around 3,600 and there are not many rational investors who think it is heading back up soon.

Events like these can understandably deter people and institutions from investing in emerging markets. They are volatile, illiquid and lack transparency. Asia though is not China – other equity markets in Asia, such as Singapore and Hong Kong, are far more liquid, transparent and better regulated.

Meanwhile ignoring emerging markets entirely is a huge mistake for any long-term investor, since the fundamentals are impossible to argue with.

Martin Gilbert, founder shareholder and Chief Executive of Aberdeen Asset Management PLC
Aberdeen Asset Management chief executive Martin Gilbert  Photo: Geoff Pugh

At this point I should declare my interest. My company, Aberdeen Asset Management, is one of the world’s leading emerging market investors. It has been since my colleague Hugh Young decided to set up our Asian investment operations in Singapore and flew there with little more than a briefcase and a sense of purpose.

Today we are one of the largest investors in emerging markets. (Significantly though we have never been that keen on investing in China, for precisely the reasons that are unfolding in Shanghai now).

We have focused on Asia and emerging markets because we believe that emerging markets offer superior investment returns over the long term – the 20 to 30-year life of a pension fund for example. The fundamentals are hard to argue with.

For example, at the moment emerging markets are a small proportion of indices – which does not reflect their growing economic might and demographics. In fact, if you draw a circle around China, India and south-east Asia, there are more people living in that circle today than in the whole of the rest of the world.

That population is also younger and more dynamic than in the developed economies. As a result, the economies they live in are moving up the technological curve rapidly. Consider the strength of India’s IT industry, or the fact that there are now more mobile phone subscribers in sub-Saharan Africa than in Europe.

There is a powerful consensus that emerging economies will continue to outperform the developed world for the next 35 years, so much so that PwC predicts that by 2050 not only will China be the world’s largest economy by some margin but that India will have also overtaken the US and pushed it into third place.

Despite this shift, there will always be bumps, bubbles and corrections along the way. Which is why it is better to be a stock picker and fundamental investor on a case by case basis and invest for the long term rather than chase market trends.

So Aberdeen will continue to invest in high quality businesses in Asia and Latin America, however unfashionable. If fashion is a 0.07pc yield on a German government bond, we’ll look elsewhere.

• Martin Gilbert is chief executive of Aberdeen Asset Management

Original article here

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