Trump leaves emerging markets in wait-and-see mode

Investors are optimistic but worried about US president’s trade and immigration stance
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FEBRUARY 10, 2017 by: Cat Rutter Pooley
Emerging markets-focused asset managers could be forgiven for wanting a quiet life. What
looked like a recovery in 2016, reversing years of heavy outflows, sharp share price falls and
declining investor interest in the asset class, was cut short abruptly by Donald Trump’s victory in
the US presidential election in early November.

The monthly survey of global fund managers by Bank of America Merrill Lynch in early January
showed investors were underweight in emerging market equities for the first time in nine
months.

By the end of the month they had changed tack and invested $7.4bn in emerging market funds,
according to EPFR, the data provider.

The question for emerging market fund houses now is whether 2016 was a turning point and the
“Trump tantrum” just a blip, or if this year will resume the outward trend for flows that has
caused Aberdeen Asset Management alone to suffer $100bn of redemptions.

The likes of Franklin Templeton, Aberdeen and Ashmore, the listed asset management
companies with substantial exposure to emerging economies, will hope 2016 marked the start
of a renaissance.

Ashmore, which specialises in emerging market debt, was upbeat in its quarterly trading
statement last month. While the fund house confirmed net outflows of $700m in the three
months to the end of December, chief executive Mark Coombs said asset prices had
strengthened in December and through the new year.

“The combination of attractive absolute and relative returns, accelerating [growth in gross
domestic product] and low allocations all support the expectation of further strong performance
in 2017 and a return to the improving flow trend seen for most of 2016,” the head of the FTSE
250-listed manager said.

Mr Coombs is not alone in his optimism. Calstrs, the second-largest US public pension scheme,
signalled its enthusiasm for the asset class last month when it launched a tender process to find
up to four active managers focused on emerging markets.

And Markus Stadlmann, chief investment officer at Lloyds Private Bank, says he is likely to
continue increasing his exposure after ending a five-year absence from EM assets last year.

“For the first time in five years, in April 2016 we allocated money back to emerging markets. We
started with a smaller allocation to both equities and bonds, and we will probably increase that
allocation this year,” he says.

But given the turbulence of the past three years and the unpredictability of President Trump,
unsurprisingly some managers are nervous about calling 2016 an inflection point.

Gary Greenberg, head of emerging markets at Hermes Investment Management, the

UK-headquartered fund house, says flows to EM managers are unlikely to pick up again until
investors have more clarity about Mr Trump’s policies on trade and immigration.

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Since taking office, Mr Trump has withdrawn the US from the Trans-Pacific Partnership — the
trade deal between the US, Japan and 10 other Asian countries that took years to negotiate —
in a move that puts his protectionist campaign rhetoric into action.

He has also put renegotiating Nafta, the free-trade agreement between the US, Canada and
Mexico, at the top of his presidential agenda.

“A trade war is not something that is going to make you want to invest in China. A huge wall and
the dissolution of Nafta would not make you want to put your money into Mexico. Visibility is
extremely poor at the moment, and until visibility lifts, we will not see much in the way of flows,”
Mr Greenberg says.

James Donald, head of emerging market investments at Lazard Asset Management, the US
fund manager overseeing $168bn of assets, agrees Mr Trump has left EM investors in
wait-and-see mode.

Mr Trump’s trade policy represents a risk factor that, along with commodity prices and interest
rate rises, could have negative effects on EM investment, he says. If Mr Trump’s policies turn
out to be relatively benign, then emerging markets could do extremely well. “We will know [more
about the president’s policy agenda] in the next year and that could be very, very positive for
emerging market investment,” he says.

Managers and analysts emphasise that, despite the global uncertainty, underlying company
valuations remain appealing even after the strong performance in 2016, when emerging
economies accounted for eight of the 10 best-performing stock markets.

Valuations [in EM] are not as cheap as this time last year, but they are still absolutely cheap
“Valuations [in EM] are not as cheap as this time last year, but they are still absolutely cheap;
cheap relative to the market itself and relative to other asset classes,” says Andrew Cormie,
leader of the global emerging markets team at Eastspring Investments, the Asian asset
management arm of Prudential, the insurer.

And in an environment where investors are hunting for yield, outperformance by emerging
market investments may drag investors back to the asset class.

John Malloy, co-head of emerging and frontier markets at RWC Partners, the fund house
part-owned by Schroders, the UK’s largest listed asset manager, says that, ultimately, investors
chase performance.

“If emerging markets are up and investors are underweight, they are going to look to close that
underweight. Valuations are cheap; economies are stabilising. Brazil, India, Indonesia are
focused on economic growth and there is a story people can buy into. We could see flows
happen.”

Emerging markets outlook for 2017

Brazil
Brazilian shares were the best-performing asset globally over the 12 months to the end of
January, returning 121 per cent, according to data from BofA Merrill Lynch. Brazilian stocks did
very well through January, but investors including Lazard and Eastspring have scaled back their
exposure after strong growth last year. “In Brazil we were overweight [last year], but we have
now sold out. We are underweight as a result of good performance,” says Andrew Cormie,
leader of the global emerging markets team at Eastspring.
Turkey
In contrast, Turkey has not been popular with investors of late. Political instability, combined
with a falling currency and rising inflation, has not encouraged flows. That has pushed company
valuations down, according to James Donald, a portfolio manager at Lazard. “We have not seen
a lot of the Turkish stocks much cheaper than they are now. Some of the valuations in Turkey
are very attractive.”
Peru
Fund managers are generally positive about the prospects for Latin American debt and equities,
with the exception of Mexico.
Peru is cited by both Hermes and Amundi as a market with good prospects for 2017.
“Valuations are very reasonable,” says Patrice Lemonnier, head of emerging market equities at
Amundi. “Among Latin American markets, Peru is one of the countries with the highest growth
potential.”