Pimco Adviser Sees ‘The Trade of a Decade’ in Emerging Markets

Morning Meeting: Emerging Market FX Opportunities
  • Research Affiliates joins BlackRock, Templeton in bull camp
  • Pimco All Asset Fund held 35% in emerging assets as of January

Emerging-market assets are so cheap that they may be “the trade of a decade,” according to Research Affiliates LLC, a sub-adviser to Pacific Investment Management Co., one of the world’s biggest money managers.

They’re joining a growing number of investors, including BlackRock Inc., Franklin Templeton and Goldman Sachs Asset Management, who are turning bullish on emerging markets after three years of underperformance. With borrowing costs at the highest levels since the depths of the global financial crisis, bond investors are being compensated for challenges ranging from falling commodity prices to China’s economic slowdown, BlackRock said Tuesday.

“The exodus from emerging markets is a wonderful opportunity -- and quite possibly the trade of a decade -- for the long-term investor,” Christopher Brightman, chief investment officer at Research Affiliates, said in a post on Pimco’s website Wednesday. “We are increasingly confident of our positioning in emerging market stocks and bonds.”

‘Exceptionally Cheap’

Developing-market securities accounted for 35 percent of the Pimco All Asset Fund and 39 percent of the Pimco All Asset All Authority as of Dec. 31, according to Brightman, who is based in Newport Beach, California. The two funds, managed by Rob Arnott who co-founded Research Affiliates in 2002, had combined assets of about $29 billion at the end of January, data compiled by Bloomberg show.

Brightman said emerging-market stocks are “exceptionally cheap” after MSCI Inc.’s benchmark gauge declined 30 percent over the past three years.

He pointed out that the so-called Shiller P/E Ratio, a measure of valuation based on cyclically adjusted price-to-earnings ratio, fell to 10 in January. There have been only six times when the measure has dipped below 10 over the past 25 years. In the following five years, the stocks rallied an average 188 percent, according to Brightman, who oversaw the endowment at the University of Virginia before joining Arnott’s Research Affiliates.

“From the rear-view mirror, the bear market in emerging markets has been painful,” Brightman wrote in the post. “When we look out of the windshield, however, these very asset classes offer the highest potential returns available to today’s opportunistic investor.”

Contrarian Investing

The MSCI Emerging Markets Index was little changed at 9:07 a.m. in New York, capping its decline this year at about 7 percent. The gauge trades at 1.3 times net assets, near its lowest level in seven years. Benchmark measures of Chinese, Brazilian and Russian shares all trade below price to book.

Arnott, who developed the two funds for Pimco in 2002 and 2003, helped pioneer what he calls fundamental indexing, an approach designed to limit risk and beat benchmarks over the long haul by favoring undervalued assets.

The contrarian approach hasn’t been successful in recent years, partly because assets in developing countries continued to decline. The $20 billion All Asset Fund lost 11 percent over the past year through Feb. 23, compared with a decline of about 7 percent in the Standard & Poor’s 500 Index on a total return basis.

Value Stocks

Brightman said in the post that the recent underperformance of value-oriented stocks in developing nations has been unusual.

Value stocks have lagged their growth-focused peers by more than 5 percent annually over the past three years through 2015, a rare occurrence since 1997, according to Brightman. When it did happen, the relatively cheaper value companies returned 6.7 percent more than growth equities annually in the following three years.

This history demonstrates that asset prices tend to converge to their long-term average, a strategy his company pursues, Brightman said.

“It is a manifestation of a core tenet of our investment philosophy: the largest and most persistent active investment opportunity is long-horizon mean reversion,” he wrote.

(A previous version of the story corrected the spelling of Rob Arnott.)

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