Emerging Markets, Even in Turmoil, Have a Place in a Portfolio

Mutual Funds Emerging Markets, Even in Turmoil, Have a Place in a Portfolio By TIM GRAYJULY 15, 2016 Severstal’s Cherepovets Steel Mill in the Vologda region of Russia. Low prices for commodities, especially oil, have sapped stock markets in places dependent on natural resources, like Russia, making investors nervous. Credit James Hill for The New York Times Over the last five years, investors in emerging-markets mutual funds have paid plenty and gotten little in return. Emerging-markets funds lost an annualized average of 3.19 percent over the last five years, Morningstar said. Yet they are far more expensive, on average, than actively managed domestic large-cap funds, which returned about 10 percent a year annualized for the same period. Expense ratios for actively managed emerging-market funds were 1.55 percent, compared with 1.15 percent for domestic large-caps. Investors have responded by fleeing emerging markets; money is churning out of the sector’s funds and E.T.F.s. Total net outflows hit a new high in 2015, when nearly $75 billion exited, according to EPFR Global in Cambridge, Mass. Through June this year, $7 billion more has been withdrawn. The exodus is understandable, given both the returns and the worrisome headlines streaming in from around the globe. Just last month, the British referendum to leave the European Union roiled markets worldwide. MSCI’s Emerging Markets Index fell as much as the British-focused FTSE 100 in the days just after the ballots were counted. The vote was an additional bedevilment for emerging markets already made skittish by slower growth in China — some commentators fret about a real estate bubble and banking crisis there — and a political crisis in Brazil. On top of that, low prices for commodities, especially oil, sapped stock markets in places dependent on natural resources, like Russia, South America and the Middle East. The turmoil is a turnabout from just a few years ago. Then the acronym “BRIC” — for Brazil, Russia, India and China — was bandied about in investment circles as shorthand for the rise of a brash new bunch of economic powers. Lately, BRIC has become a four-letter epithet. The reaction of emerging markets to the British vote has also underscored a new reality for investors: Emerging markets no longer provide the diversification benefit they once did, said Roger A. Aliaga-Díaz, senior economist with Vanguard’s Investment Strategy Group. “Correlations have increased since the 2000s between emerging markets and developed ones,” Mr. Aliaga-Díaz said. During the surge of the 2000s, one of the attractions of emerging markets was that they tended to zig when the developed world zagged. They could buffer the ups and downs of developed markets in a diversified portfolio. To a greater extent these days, developing and developed markets have tended to move together. Portfolio managers of emerging-markets funds say today’s worries, like yesterday’s euphoria, may be exaggerated. “In terms of history, the last couple of years isn’t remarkable,” said James F. Syme, senior fund manager of the Johcm Emerging Markets Opportunities fund. “Emerging markets have always been two steps forward and one step back. In the ’80s, we had the Latin American debt crisis, and in the ’90s, the Asian tigers and then the Asia crisis. All asset classes tend to be characterized by boom and busts. Emerging markets is a riskier asset class, so the booms and busts are bigger.” Today’s economic challenges are real but manageable, said Joanne C. Irvine, a portfolio manager for the Aberdeen Emerging Markets fund. “Given the significant underperformance of emerging markets in recent years, you’d think most of the countries were in crisis, but the economies and corporate balance sheets are mostly in reasonably good shape,” she said. “Global growth has been very weak, and that’s led to weak emerging-market exports.” Even so, many emerging countries remain healthier than developed ones, with higher growth rates and lower debt levels, she said. And many of them have young, growing populations striving to join the world’s middle class. China’s economy has been the engine of the developing world, but after a two-decade surge, growth there is slowing as the country shifts from an export-led economy to a consumer-driven one like the United States, said Arjun Jayaraman, co-portfolio manager of the Causeway Emerging Markets fund. “They’re going from a growth rate of high single digits to, realistically, 3 to 4 percent a year,” he said. The Chinese government’s official growth target is 6.5 to 7 percent this year. Photo Workers at the Cherepovets Steel Mill in the control room of the Severyanka blast furnace, once the largest in the world. Credit James Hill for The New York Times That slowdown has caused worldwide commodity prices to sag. When China was investing heavily in infrastructure and industrialization, commodity producers thrived; now they’re pinched. A strong dollar has meted out additional pain. Many companies and countries in the developing world borrow money in dollars, so a stronger dollar increases the real cost of their debts, said David Semple, portfolio manager of the VanEck Emerging Markets Equity. A stronger dollar also hurts the returns of American investors because the returns of emerging-market companies, denominated in weaker local currencies, must be translated into dollars. “For emerging markets, the precondition for them doing better is for the dollar to not accelerate strongly,” he said. The emerging-markets sector is split by the debate over active management versus indexing just as every sector is. Much of the discussion comes down to costs: It’s usually cheaper to run an index fund than an active one, and costs eat away at investors’ bottom line. The average emerging-markets index fund carries an expense ratio of 0.52 percent, compared with the 1.55 percent charge levied by the average actively managed emerging-markets fund, according to Morningstar. Some of the better-known index funds levy even lower fees. The Vanguard Emerging Markets stock index fund charges 0.33 percent for its investor shares, while BlackRock’s iShares Core MSCI Emerging Markets E.T.F. charges 0.16 percent. For the most part, the higher costs for active management haven’t translated into better performance, said Todd L. Rosenbluth, director of E.T.F. and mutual fund research for S&P Global Market Intelligence. Based on trailing returns, two-thirds of emerging markets funds underperformed S.&P.’s emerging-markets index over the one, three and five years ending in December 2015, he said. “On the positive side, that means one out of three did outperform,” he said. “There’s some value to active management, but the cheaper your actively managed fund can be, the better,” he said. Costs aside, Patricia Oey, a senior analyst for Morningstar, said that active funds aren’t locked into the country allocations required by index funds. Both the Vanguard and iShares funds, for example, allocate about a quarter of their assets to Chinese stocks. That amount could grow in coming years, because China’s domestic A-share market is opening to foreign investors, she said. Given the heft of China’s economy — the world’s second-largest, after the United States — index providers might opt to include more Chinese companies. A way in which some emerging-markets managers avoid overexposure to any particular country is by also investing in developed-world multinationals that sell into the emerging world. Sammy Simnegar, portfolio manager of the Fidelity Emerging Markets Fund, takes that approach. As of the end of April, about 20 percent of his fund’s assets were developed-world stocks. He said that too many of the biggest, best-known companies in emerging markets, especially in China, are state-owned enterprises, which he shies away from. “In my view, those aren’t run for shareholders — they’re run for the state,” he said. “I’d rather invest in an A. O. Smith, a U.S. company that makes water heaters. About a third of their revenue is from emerging markets, particularly India and China.” Just as portfolio managers damp risk by diversifying, individual investors can do the same with their personal portfolios. Ms. Oey of Morningstar said holding 10 percent of a stock portfolio, mirroring the proportion of emerging markets in the world’s stock market capitalization, would make sense for a long-term investor. A person with 60 percent of her money in stocks would then put 6 percent in emerging markets. Campbell R. Harvey, a finance professor at Duke University, said he saw 10 percent as a floor, not a ceiling. In a 2014 paper, professors Harvey and Geert Bekaert of Columbia University noted that emerging markets account for about 30 percent of world G.D.P. Thus, they wrote, “Strategic allocations somewhere in between market capitalization weights and G.D.P. weights are easy to defend.” Whatever else investors do, they should guard against the tendency to dump their holdings based on recent discouraging news or weak returns, Professor Harvey said. “The biggest mistake retail investors make is selling stocks if they go down and buying the ones that have gone up,” he said. “This holds true for asset classes, too,” he added. “Just because emerging-markets equity has had low returns recently does not mean you should sell. One-third of world G.D.P. is being driven by emerging-market economies, and it makes sense that a globally diversified portfolio should have exposure to them.” A version of this article appears in print on July 17, 2016, on page BU16 of the New York edition with the headline: An Exit From Emerging Markets May Be Hasty. Order Reprints| Today's Paper|Subscribe

Sky City: China to erect world's tallest tower in 3 months, building 5 stories a day

Get short URL email story to a friendprint version Published: 25 November, 2012, 19:00 TAGS: Asia, Architecture Proposed 220 floor Sky city (image from Wikipedia) China has embraced the challenge of putting up the world's tallest building in only 90 days. The 838-meter skyscraper, dubbed Sky City, is set to house 17,400 people as well as a hotel, a hospital, several schools, offices and apartments. ­Construction workers from the Broad Sustainable Building company are expected to build at a rate if five stories a day to meet the deadline. To speed the process up, they will reportedly use the 'prefabrication' technique in which blocks of the building are constructed offsite and then pieced together. The skyscraper, located in Hunan Province's capital Changsha, will feature over 100 high-speed elevators, and is expected to be able to withstand a magnitude 9.0 earthquake. When completed, the building will be 10 meters taller than the Dubai landmark Burj Khalifa, the world's current tallest building, which took five years to build. China's Sky City is set to cost half as much as the Burj – about $630 million. China-based Broad Sustainable Building will employ several thousand workers for the ambitious project. The company has already built 16 structures in China, including a 30-story hotel constructed in 15 days. =============== Analysis: "Caveat emptor" as foreigners rush to ride China rebound Sun, Nov 25 20:33 PM EST 1 of 3 By Vikram Subhedar HONG KONG (Reuters) - Foreign investors have started rebuilding their China equity portfolios, tempted by low valuations after two years of market underperformance and signs economic growth may be stabilizing. They have pumped nearly $4 billion into Chinese equity funds in the past two months alone, trying to get in early on what they hope will be a sustained rally. But sentiment looks to be running ahead of fundamentals. There are clear risk signals for the Chinese market -- including sluggish earnings, rising corporate debt and retail investors looking for other opportunities -- even if the broader economy gathers strength. "Valuations are attractive and fears of a major slowdown in China seem to be waning, while China still promises growth faster than the rest of the world," says Paul Gillis, professor at Peking University's Guanghua School of Management. "But most of the problems affecting Chinese stocks -- accounting fraud, the variable interest entity and regulatory stand-offs between the U.S. and China -- have not gone away and still need to be solved." Illustrating that growth does not translate into equity gains, the MSCI China stock index has fallen more than 40 percent since its launch in 1992. Over the same period, China's nominal GDP has increased by 15 times. REBALANCING The shift in foreign investor attitudes is clear. Bank of America Merrill Lynch's global survey of fund managers, covering 248 managers with $695 billion of assets under management, found confidence in China's economy was at a three-year high. In October, Chinese shares listed in Hong Kong, known as H-shares and the main gateway for foreign investors into China, jumped 7.6 percent to easily outpace other regional benchmarks. "I think most fund managers are looking at the fundamental mismatch in their portfolio between their direct exposure to China and the role China plays in the global economy, often very little versus one hell of a lot," said Michael McCormack, executive director at China-focused fund consulting firm Z-Ben Advisors. "Investors are now trying to rebalance that." One attraction is valuations. The MSCI China index, the most popular benchmark for China funds, has consistently underperformed Asian markets over the past two years, following a stellar run where it nearly tripled in value between October 2008 and November 2010. The index trades on a forward price-to-earnings multiple of 9.2, cheaper than Brazil on 9.9 and India on 13.2, and a lure to investors hoping to get in early on another substantial upswing. The H shares are at price-to-book ratios around four times lower than in 2007, according to Thomson Reuters data. Those valuations and signs the economy is improving -- Thursday's flash PMI reading showed the first expansion in manufacturing in 13 months -- have piqued interest, and it seems investors are worried about missing out on riding the recovery. Data from fund-flow tracker EPFR Global shows inflows into China equity funds accounted closed in on $4 billion over the 10 weeks to mid-November, and accounted for more than half of the flows in Asia ex-Japan funds in the week to November 15. " has bottomed out and found a new level, so people don't want to be negative about China anymore," said Stuart Rae, chief investment officer of Pacific Basin Value Equities at AllianceBernstein. The company's $879 million Asia ex-Japan fund, launched in November 2009, is now overweight China for the first time, said Rae, who also manages its US$150 million QFII China fund. PICK CAREFULLY As Beijing's new leadership settles in, the stock market's fundamentals are back in focus and they could make the recent enthusiasm seem premature, said Simon Grose-Hodge, head of investment advisory for South Asia at private bank LGT. For one, there is unlikely to be a repeat of anything remotely like the 4 trillion yuan ($640 billion) stimulus package that guided the Chinese economy through the 2008/09 global financial crisis. Instead, there may be smaller, more targeted spending plans that don't make cheap credit available across the board. And longstanding issues for investors, such as transparency, reform of state-backed companies, corporate governance and regulator interference in the market, have yet to be properly addressed despite some positive noises from authorities. So while the H-shares in Hong Kong are showing signs of life, China's domestic stock markets are languishing near three-year lows and on the nose with retail investors. Two-thirds of Chinese companies that have posted third-quarter earnings missed expectations, according to Citi Private Bank. Profits fell an annual 5.8 percent, and analysts, on average, are still cutting earnings expectations for next year. Leverage has soared above comfortable levels, with Beijing-based consultancy GaveKal-Draganomics expecting corporate debt to hit 122 percent of GDP by the end of the year, up from 108 percent at end-2011. Rising non-performing loans (NPLs) pose a risk for the banks, a hangover from cheap credit as part of the 2008/09 stimulus. Goldman Sachs & Co estimates the NPL ratio is more than six times the official reported rate of 0.97 percent. Further, China's industrials were owed more than 8 trillion yuan in net receivables at the end of September, up 16.5 percent from a year earlier, according to the National Bureau of Statistics. HSBC says the annual pace of profit growth of non-financial companies in the CSI 300, which tracks the performance of China's A-share market, has been falling for the last three quarters, while the quality of earnings -- measured as the ratio of free cash flow to net profit -- is in negative territory. The CSI300 is down 7 percent this year, following a 25 percent drop in 2011 and a 12.5 percent fall in 2010. "Five years back in 2007 the (Chinese) market was one of the most expensive and now it's cheap on a par with Korea -- it's one of the cheapest markets in Asia," said Pacific Basin's Rae. "There is lots of stuff that's cheap -- some has recovery potential but then some is cheap for a reason." ($1 = 6.2345 Chinese yuan) (Additional reporting by Shanghai Newsroom; Editing by John Mair) =======================