Emerging markets seem to have a special kind of a raw appeal to fund managers. They are risky enough to challenge them and high-yielding enough to satisfy them. How do international emerging markets look to fund managers today? And are South Asian markets, Pakistan in particular, on the radar screens?
Dawn’s Naween A. Mangi in New York explores the prospects for emerging markets like Pakistan in discussions with a fund manager.
THROUGH all the ups and downs of international share markets emerging markets somehow never fail to charm fund managers. Sure, there’s temporary disdain followed by new theories of investing but on the whole, institutional investors are usually easily lured back to the volatile appeal of emerging markets. Rajiv Jain, managing director of Swiss group, Vontobel Asset Management Inc,. is no different. He’s been looking at emerging markets for years.
His forecast: Emerging markets will still outperform their developed counterparts for the next three to five years although the margin will be significantly less than previous years.
Not bad. Even if it does come at a time when several emerging markets have just doubled or multiplied. Jain says emerging markets historically have grown at faster rate than developed markets but also tend to go through bouts of exuberance and depression.
“Emerging markets had a strong run from 1989 to 1993 and at the time, everyone was pretty excited. These markets were trading at [price-earning multiples of] 25 times plus and even 40 times.”
This period was followed by a spell of choppy waters after which came the Mexican crisis, the Thai crisis and the Russian crisis. “The markets then bottomed out and were very cheap,” Jain says. “It became like toxic waste to talk about emerging markets.” Changing fortunes:
However, the crises then led to a change in the mentality of both corporates and governments and external accounts (which had led to the troubles in Asia) were improved. Since then, reserves across Asia have been built up, current accounts are in surplus, interest rates are low and unusually, emerging markets have become suppliers of credit.
“Because of all this, stocks which were pretty cheap in 1999, saw massive multiple expansion with indices doubling in some cases,” Jain says. Currently, he sees the room for such expansion as much lower and sees emerging markets more or less at parity although valuations are still lower than those in developed markets but not dramatically lower. “At this point one has to be careful justifying that these markets deserve the same ratings or premiums because corporate governance tends to be worse. “Valuations are reasonable but they are not cheap. However, earnings growth is still high and margins have improved.” He sees several opportunities in emerging markets, at least two names per country but significant possibilities exist in Brazil and South Africa.
Pakistan’s prospects: Jain says all the three major share markets in South Asia—India, Pakistan and Sri Lanka—have performed reasonably well. “[In Pakistan], there is a lot of excitement for different reasons but things haven’t improved as much as people would like to believe,” he says.
His firm has no current holdings in Pakistan. “We missed the improvements in Pakistan over the last few years because they are led by a top down approach and that makes things difficult to ascertain from [our] bottom up approach,” he says.
Discussing Pakistan’s share market, the fund manager says it is too narrow to allow broad-based investing. “There is also a liquidity issue and a lot of people got burned in the mid-nineties, including us.— “The breadth of the market is not there in terms of what to buy and although our wait-and-see attitude has made us miss a big run in the last few years, it remains to be seen how sustainable the changes in the economy and corporate environment are. The jury is still out on that.”
He also says the corporate regulatory environment needs to be improved significantly. Nonetheless, his firm has recently been researching a few big name companies to consider for investment. “Smaller markets tend to fall under the radar and as the valuations for larger markets get out of whack, people tend to look at the next level.” Jain says his company will look to see sustainability in profitability before making an investment decision in Pakistan.
“We tend to come late in the game and we don’t buy turnarounds,” he says. “We wait for the turnaround to happen because 80 per cent of expected turnarounds never turn around.”
He says corporate profitability in Pakistan is decent but its sustainability is still a matter of time. Jain also says new listings in Pakistan appear “reasonably attractive.” The privatization programme, he says, also appears on the right track but it remains to be seen how far and deep it will go. “When any country says we will privatize to the extent of X, it usually privatizes x minus 70 per cent,” he says. “But privatization does bring efficiency gains and generates jobs.”
There is great room for improvement in the market regulatory system in Pakistan. “My impression is that these things gain impetus once markets have performed better and interest comes in from investors and the government.”
Market manipulation is less of a concern since his firm takes a longer term view where it is difficult to manipulate prices. “Manipulation in the short term can be useful because if prices are unduly depressed, they may pick up,” he says.
“Insider trading regulation is lax in a lot of markets but it is not the end of the world even though it should be improved.”
On the whole, regulatory matters are of critical importance. Jain says his company has not bought anything in China because corporate governance is an issue at 75 per cent of all companies and the rest are too expensive.
Corporate governance in emerging markets has improved in the last ten years but is still far, far away from where it should be. The environment in which markets are regulated is also critical, Jain says. In this respect, South Korea and Malaysia have done well. In India, there have been improvements, but while rules have been developed, implementation remains lax. “There are 5,000 listed companies but 90 per cent of them are junk,” he says. “There are a hand full of companies which are good and they are [distinguished] by how the business is run.”
Jain says the state of the economy only figures in his analysis to the extent that it fits into individual stock analyses. The institutions required to run a country and the implementation has to be there, but beyond that, the [economic indicators] don’t tell you much.”
Security, meanwhile, is not much of a concern to Jain when making investment decisions. “At the end of the day, it’s the business which drives our decision and business should have inherent traits to sustain these pressures,” he says.
Emerging markets seem to have a special kind of a raw appeal to fund managers. They are risky enough to challenge them and high-yielding enough to satisfy them. How do international emerging markets look to fund managers today? And are South Asian markets, Pakistan in particular, on the radar screens?
