Where Are the Opportunities in Emerging Markets Today?

We take a closer look at India, Taiwan, and Malaysia.

Patricia Oey 14 November, 2014 | 17:33
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It is difficult to find attractively valued assets today. Interest rates in the developed world remain near record lows, and investors continue to pour into riskier assets, driving up valuations. U.S. stocks have enjoyed a five-year rally, with the S&P 500 currently trading at a trailing 12-month price/earnings multiple of 18 times, above their historical average of 15 times. Certain pockets of the emerging markets are also trading at lofty valuations, thanks to new market-friendly reforms (Mexico) or a relatively strong near-term growth outlook (the Philippines).

Markets trading at depressed valuations, such as Russia and China, are likely to remain cheap in the medium term. Russian firms are operating in a weak domestic environment that is further hampered by Western sanctions and falling oil prices. As for China, many large firms, which used to enjoy a relatively oligopolistic operating environment, face an uncertain future as the government pursues a confounding reform agenda that tries to combine both market liberalization and state-control ideologies.

 

Trailing 12-Month P/E Ratios


  - source: MSCI. Data as of Sept. 30, 2014.

Annualized 2-Year Returns


  - source: Morningstar Direct. Data as of Sept. 30, 2014. The MSCI indexes are market-cap-weighted and denominated in U.S. dollars.

India
India has been one of the best-performing markets this year (the MSCI India Index is up 25% year to date)--so now might not seem to be the best buying opportunity. Both domestic and foreign investors have fueled a strong rally based on their optimism that newly elected Prime Minister Narendra Modi will foster a more business-friendly regulatory environment, as he did when he was the leader of the Gujarat state in western India. But there is a new catalyst that may help sustain the rally in the near term: falling oil prices. Historically, one of India’s challenges has been the government’s inability to cut fuel subsidies. These subsidies (the diesel subsidy is estimated to cost $10 billion a year) have increased the country’s fiscal deficit, hindered its ability to spend on infrastructure, and negatively affected its credit rating. But Modi used the recent decline in oil prices as an opportunity to end the diesel subsidy earlier this month, at a time when it would have a relatively small impact on consumers. Lower oil prices should also result in many positive knock-on effects on the domestic economy, as India imports about 70% of its oil needs. Pressure on the country’s current account is easing and inflation is falling, which may prompt India’s central bank to lower rates earlier than expected. Consumers, with more money in their pockets, are feeling more confident. This improving macroeconomic environment, combined with Modi’s ambitious reform plans, may create a virtuous cycle and set the stage for India’s long-awaited next phase of growth.

There are 10 India-focused funds in Morningstar’s database--five passively managed ETFs, and five actively managed funds. The five ETFs each track different benchmarks, and as such their portfolios have slightly different average market capitalizations and sector exposures. While four of the passively managed funds are fairly similar, WisdomTree India Earnings ETF EPI has a heavier weighting in the energy sector and a lower weighting in the consumer sector, relative to its ETF peers. This fund also has a lower average market capitalization. Matthews India MINDX is an actively managed open-end fund that carries a Morningstar Analyst Rating of Bronze. This fund is heavy in consumer (which represent 27% of its portfolio) and industrial (18%) names and has no exposure to energy names. Those comfortable with the closed-end fund structure can consider India Fund IFN and Morgan Stanley India IIF. Each fund has a 20-year track record.


  - source: Morningstar Direct

Taiwan 
Taiwan is the world's largest supplier of contract computer-chip manufacturing services and is a major producer of LCD panels, DRAM computer memory, networking equipment, and consumer electronics. These technology companies account for a significant portion of Taiwan’s economic output, and Taiwan-focused funds tend to have an average 50% weighting in the tech sector. The outlook for these tech companies is healthy. Gartner, in its latest worldwide devices forecast, said that it expects personal computers to grow at a low-single-digit rate over the next few years, driven by a refresh cycle. This is a reversal from the declines seen in recent years as PCs lost market share to tablets and mobile phones. Tablet unit sales are expected to continue rising, albeit slower than the 11% growth rate in 2014, and demand for mobile phones is expected to grow about 5% in 2015. We also note that some of Taiwan’s largest tech companies, such as Taiwan Semiconductor TSM and Hon Hai, are key players in Apple’s AAPL supply chain. In its fourth-quarter results, Apple said it is still seeing significant backlog for its new iPhones and expects strong sales in China. On the domestic front, the macroeconomic environment in Taiwan is stable. Manufacturing data remains positive, unemployment is falling, and Moody’s said in August that the outlook for Taiwan’s banking system remains stable.

There are four Taiwan-focused funds in our database. IShares MSCI Taiwan EWTtracks a market-cap-weighted index, whereas the First Trust and SPDR ETFs track fundamentally weighted indexes. The sector weightings of these three funds are similar, but the First Trust and SPDR ETFs are tilted toward mid-caps, relative to the iShares fund. There is one actively managed option: Taiwan Fund TWN, which is a closed-end fund. However, in January 2014, the fund changed investment managers from Martin Currie/APS Asset Management to Allianz Global Investors.


  - source: Morningstar Direct

Malaysia
As a smaller market, Malaysia is often overlooked, but it is home to many well-run firms exposed to positive growth trends. The country’s leaders have stated that their goal is for the economy is to reach "developed status" by the end of the decade. To achieve this, Prime Minister Najib Razak is dismantling subsidies, boosting education standards, and increasing his focus on attracting foreign investment. Malaysia already ranks favorably in the eyes of foreign investors--according to the World Bank’s Ease of Doing Business Survey, Malaysia ranked number 6, the highest among emerging-markets countries and higher than many developed countries. There is only one Malaysia-focused fund, iShares MSCI Malaysia EWM. The banks (which account for about a third of the portfolio) have healthy balance sheets and many are now regional operators following acquisitions of smaller players in neighboring countries. In the medium term, these banks should benefit from the government's initiatives to turn Kuala Lumpur into a major financial center, particularly in the area of Islamic banking. Another important area of the Malaysian economy is the palm oil sector, as Malaysia is the world's largest exporter of palm oil. Palm oil plantations are owned primarily by conglomerates, which in this fund may be classified as industrial, consumer discretionary, or consumer staples firms, depending on their mix of business. Demand from China, weather, and global demand are key drivers for palm oil prices. Although this sector is very volatile, the stock prices of the publicly listed conglomerates that own palm oil plantations are less so thanks to their diverse mix of businesses.


  - source: Morningstar Direct

Investing has never been easy, and investing in emerging-markets equities can be particularly challenging. A category that is typically painted with broad brush strokes, the emerging-markets group is composed of more than 20 countries with very different economic environments, regulatory frameworks, and degrees of capital market development. Simple screens, such as P/E ratios and trailing return data, can serve as good starting points to gauge individual markets’ valuation and momentum, but a closer inspection is necessary, as it will often reveal a plethora of drivers, some expected and some unexpected. Those willing do a little homework may uncover interesting buying opportunities. 

 

Disclosure: Morningstar, Inc.’s Investment Management division licenses indexes to financial institutions as the tracking indexes for investable products, such as exchange-traded funds, sponsored by the financial institution. The license fee for such use is paid by the sponsoring financial institution based mainly on the total assets of the investable product. Please click here for a list of investable products that track or have tracked a Morningstar index. Neither Morningstar, Inc. nor its investment management division markets, sells, or makes any representations regarding the advisability of investing in any investable product that tracks a Morningstar index. 

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Patricia Oey  Patricia Oey is an ETF analyst at Morningstar.

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