Emerging markets geared for growth

Emerging markets are expected to produce “good, solid returns” this year, supported by reduced reliance on exports to the developed world as well as higher domestic demand.

But each country and sector is different. Markets are expected to rebound in 2013 following a year in which growth was hampered by the recession in Europe, the slowdown in the U.S. and domestic policy initiatives in China aimed at reducing domestic inflation.

Serge Pépin, vice president, investment strategy, with BMO Asset Management Inc. in Toronto, expects emerging markets to produce “good, solid returns” this year, supported by reduced reliance on exports and higher domestic demand.

Portfolio managers agree that certain stocks in Latin America, Eastern Europe, the Middle East and Africa represent good investment opportunities. But there is no consensus on which countries will provide the best opportunities.

“There are tremendous differences in individual countries,” says Mark Mobius, executive chairman of Toronto-based Franklin Templeton Investments Corp.‘s emerging-markets group in Singapore.

These markets will attract increasing attention among investors because “they represent a high return/low risk proposition,” suggests Bhim Asdhir, president and CEO of Excel Funds Management Inc. in Mississauga, Ont. In addition to having healthy, stable economies, their growth rates and level of foreign reserves are much higher than highly leveraged developed nations, while their public-sector and consumer debt levels are significantly lower.

Another benefit of investing in emerging markets is that they are cheaply valued, says David Kunselman, portfolio manager with Excel Investment Counsel Inc. in Mississauga. Stocks on the MSCI emerging markets index are trading at 10.7 times forward 2013 earnings, he points out, compared with 12.9 times for stocks on the MSCI world index.

Economic growth is expected to average 5.7% in sub-Saharan Africa, 3.9% in Latin America and the Caribbean, 3.6% in the Middle East and North Africa, and 2.6% in central and eastern Europe, according to the September 2012 issue of the International Monetary Fund’s World Economic Outlook.

Consumer staples and consumer discretionary stocks are expected to be the leading sectors in most emerging countries as disposable income continues to increase, swelling the size of the middle class. Says Asdhir: “Growing consumption – now a decade-long theme – is expected to remain intact in 2013.”

Banking is another sector that offers substantial opportunities in most emerging countries. “Banks have not participated in the consumer banking revolution,” Mobius says, “making companies that can grasp these opportunities good investments.” This includes companies offering mortgages and credit cards.

Developing nations are expected to produce “good, solid returns” this year, supported by reduced reliance on exports to the developed world as well as higher domestic demand. But each country and sector is different

From a regional perspective, Latin America is on solid economic footing, with inflation under control, unemployment low and a healthy consumer base, especially in larger economies such as Brazil and Mexico, says Ingrid Baker, head of emerging-market equities with Invesco Ltd. in Atlanta and portfolio manager of Invesco Emerging Markets Class Fund.

In Mexico, Baker favours America Movil SAB de CV, the leading wireless services provider in Latin America. Asdhir prefers homebuilding and construction companies because, he says, “there is a massive housing shortage in Brazil and Mexico.”

Both Pépin and Asdhir like infrastructure firms, which will benefit from the massive development required for Brazil to host the World Cup in 2014 and the Summer Olympics in 2016. Pépin also favours Cemex SAB de CV, a global building materials leader; Walmart de Mexico; and energy stocks.

Mobius favours Brazil, Mexico, Chile and Colombia. In Brazil, he particularly likes consumer products. He also prefers large banking and financial services companies, including Itaú Unibanco SA and Banco Bradesco SA; as well as energy and mining stocks, including Vale SA.

In eastern Europe, stocks are attractively valued but the region still has to “get its house in order,” cautions Mobius, as policy-makers work through reforms in developed Europe. Adds Pépin: “You will have to go stock by stock.”

Baker, who is overweighted in eastern Europe, says Russia’s economy is picking up and inflation is under control, but this economy is overly dependent on the energy sector. She favours Sberbank Rossii, the largest credit institution; oil company Rosneft OAO; and conglomerate Sistema.

Regarding Russia, Mobius is partial to Gazprom OAO, the largest natural gas company; and Lukoil OAO, the second-largest oil company. He also likes fertilizer producers and banks.

Pépin and Asdhir prefer energy stocks, but Pépin cautions: “Doing business in Russia is challenging because of bureaucratic red tape.”

Regarding the rest of eastern Europe, Pépin believes “Poland is the most thriving economy” in the region. And Baker notes that Poland’s house is in order and that it’s more export-oriented. The Invesco fund is invested in KGHM Polska Miedz SA, a big copper producer.

Turkey has benefited from the “most advanced economic reforms,” says Pépin. Asdhir also is bullish on the country. Both portfolio managers favour banks and consumption plays in Turkey.

Opportunities in Africa include mining, retail, and telecommunications, although Pépin cautions that liquidity, transparency and political instability remain risks, except in South Africa. However, Mobius believes that the frontier markets of Africa offer good investment opportunities.

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.

More articles by Dwarka Lakhan