A $1.4 Trillion Manager Says Emerging-Market Fears Are Wrong

  • Capital Group says `opportunities abound' after prolonged drop
  • Developing-nation shares ralllied with currencies in March

Seeing Value in Emerging Markets

Capital Group Cos., a manager of $1.4 trillion worldwide, says misguided assumptions among emerging-market bears have created investment opportunities after years of disappointing returns for the asset class.

It’s misleading to assume that rising U.S. interest rates will hurt developing-country stocks, because they tend to beat developed-nation peers when the U.S. Federal Reserve is increasing borrowing costs, Capital Group wrote in a note to clients. Fears about China’s slowdown may be overstated, while lower commodity prices could actually help net importers including China and India, the two biggest emerging economies, the firm said.

Capital Group’s optimistic outlook may be gaining traction in markets, with developing-nation assets surging last month after losing about a quarter of their value since 2012. By one measure, the benchmark gauge of emerging-market shares still trades at a discount to its five-year average after the largest developing countries recovered about $1.8 trillion of market capitalization in March, the biggest jump in records going back to 2007.

“Opportunities abound,” Capital Group wrote. “The long-term growth story for the asset class has not changed.”

Goldman Bullish

The money manager is adding its voice to a camp of optimists that includes Goldman Sachs Group Inc. and Research Affiliates LLC. Goldman turned positive on emerging-market debt in February, while Research Affiliates, a sub-adviser to Pacific Investment Management Co., said developing-nation assets may be “the trade of a decade.”

Capital Group’s Emerging Markets Total Opportunities Fund has returned 2.6 percent annually over the past five years, beating 84 percent of peers, according to data compiled by Bloomberg. The $2.8 billion fund, which is domiciled in Luxembourg, invests in equity, hybrid securities and bonds.

While it’s encouraging that a growing number of forecasters are bullish on emerging markets, the asset class still faces challenges, according to Tai Hui, the Hong Kong-based chief Asia market strategist at JPMorgan Asset Management.

Previous Cycles

“More strategists are now being more optimistic on EM, which I think in the long run is correct,” Hui said. But given the possibility of further U.S. rate increases, a stronger dollar and more declines in oil, “2016 is still going to be a pretty turbulent year for emerging markets.”

The MSCI Emerging Markets Index outperformed the MSCI World Index in three of four Fed tightening phases since 1988, according to Capital Group. The only exception came in the period from December 1993 to April 1995, when higher interest rates were largely unexpected, it said. The emerging-market gauge trades at 1.4 times net assets, compared with a five-year average of 1.5, data compiled by Bloomberg show.

“The end of U.S. quantitative easing and gradual increase in interest rates is a sign of normalization,” Capital Group wrote.

The emerging-market stock gauge has climbed 18 percent since Jan. 21, when it closed at the lowest level in more than six years, weighed down by the tumbling price of oil and data showing China’s slowdown was intensifying. Shares have rallied as crude prices recovered and the Fed signaled in March that it would be slower in tightening monetary policy, cutting its projections to two interest-rate increases from four in 2016. The benchmark slipped 0.5 percent in New York on Wednesday.

Committed Xi

While China’s economy will inevitably decelerate as it matures, the country will still be a strong contributor to global growth, Capital Group said. President Xi Jinping is committed to maintaining economic momentum and there’s room to cut interest rates further, the money manager said.

Valuations of emerging-market currencies and debt look attractive, Capital Group said, adding that real yields from sovereign issuers in developing countries are much higher than in advanced nations.

“Looking at these fundamentals coupled with current valuations, I believe EM debt looks attractive over a two- to three-year timeframe,” Kirstie Spence, a portfolio manager at Capital Group in London, said in a separate note to clients. “While it’s always difficult to judge when valuations have reached the bottom, I feel more comfortable with EMs that are supported by better fundamentals,” she said, without identifying any specific countries.

Capital Group was the world’s seventh-largest asset manager at the end of 2014, according to a P&I/Towers Watson survey. The firm, with $1.4 trillion under management at the end of December, oversees products including American Funds, one of the largest mutual-fund families in the U.S. by assets.

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