US investment group State Street Global Advisors, which runs $1.9tn in assets, is one of many fund houses re-shaping its product offering to encompass a much larger client exposure to the world’s fast-growing developing markets.
Emerging market exposure is growing fast and currently nudging $60bn, says SSgA’s long-serving global chief investment officer, Rick Lacaille, who expects these trends to continue, particularly boosted by the increased ease of entering some new markets with exchange traded funds.
“Passive investment into emerging markets is attractive because people want to make allocations rapidly and simply and sometimes they don’t have the governance available to select active managers,” he says.
Currently SSgA is overweight Russia, Thailand and China – the latter by 3 per cent – and has lowered allocations in its portfolios to India and peripheral East European economies, among others. This is a reversal of normal policies, suggests Mr Lacaille, with large countries currently showing cheaper valuations.
“The economic outlook in China is getting worse, but investors are trying to get ahead of the market in terms of pricing. It is an attractive market from a value perspective,” he says. “Policy levers available in China – both monetary and fiscal – are quite substantial, although they may not pull them this year, because the political changes may result in turbulence.”
He believes investors should not be overly concerned with any potential economic downside in China, but understands that many will take the opposite view. “If it turns out that more capital needs to be pumped into the banking system as a result of re-organisation, then that is more feasible in China than in Europe and other developed countries.”
Indeed, he is more concerned about financial rather than political factors, when it comes to assessing the safety of Chinese investments. “While the Bo Jilai story might be interesting from the human perspective, we are much more interested in the plumbing of the financial system and what need to be re-examined in terms of non-performing loans,” says Mr Lacaille.
“Europe is pushing emerging markets in the sense that the long-term story is very good and people translate that into an investment story. This is not irrational, but there is still big confusion between economic growth and investment returns. One does not necessarily lead to the other.”
In neighbouring Russia, SSgA sees gradual improvements emanating from an influx of some new talent into the leadership circle. Some of the more business-friendly politicians recognise that not only do dividend policies in companies need to be changed, but shareholders must be reassured with a friendlier regulatory climate.
Not only is this a cheap market, offering a “fair reward for risk”, but Russia is increasingly focusing on developing its non-energy economy.
Crucial in future thinking of emerging allocations will be the citizens’ ability to take on debt to finance property purchase, believes Mr Lacaille. “This might have been irrelevant just a few years ago in emerging markets and it wasn’t part of our thinking, but this will change in the next 20 years.”
These changes will drive a greater interest, for instance, in Chinese and Indian credit markets. “What do people do when their wealth increases? They want a stake in real estate,” says Mr Lacaille. “That may come through the banking system, but the development of mortgage-linked securities becomes increasingly likely. You need to take risk to achieve returns, so it is essential to diversify into fixed income. Emerging markets are giving you a new leg to that diversification story, starting with credit, which may then roll into other parts of the fixed income market.”
