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| > Features > Morningstar Conversations |
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| The Furious Comeback of Emerging Markets |
| by
Arijit Dutta and William Samuel Rocco
| 10-20-09 |
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Blame it on emerging markets. That seemed to be a fair line to take not too long ago, when any systemic financial crisis could usually be traced back to a series of debacles in developing markets. The current global financial crisis, however, originated right here in the United States. And yet, emerging markets were among the most brutally punished as investors indiscriminately fled all risky assets.
Many are perhaps realizing last year's verdict was too harsh. Morningstar's diversified emerging markets, Latin America, and Pacific/Asia ex-Japan categories are up between 46% and 63%, which are by far the best results among all domestic and foreign categories.
We invited fund managers Rusty Johnson, Arjun Divecha, and Andrew Foster to participate in a conversation via conference call on Aug. 3, so they could share their insights into emerging markets' investing merits and drawbacks. These veteran managers have tracked many powerful changes in this asset class over the years, and shareholders at their funds have benefitted from the investing themes they have sniffed out.
Johnson is the lead manager of Harding Loevner Emerging Markets HLEMX as well as a comanager of Harding Loevner Frontier Emerging Markets HLFMX. His high-quality growth strategy has delivered strong long-term returns with relatively moderate volatility during his 11-year tenure at Harding Loevner Emerging Markets. Divecha has led the charge at GMO Emerging Markets III GMOEX for more than 15 years. His mostly quantitative--but augmented by fundamental analysis--approach has produced strong results during his tenure. Divecha was recently promoted to be the chairman of the firm, after Jeremy Grantham, GMO's famously contrarian market prognosticator, stepped down from that role. Foster is the skipper at Matthews Asian Growth and Income MACSX. He is among the thought leaders at Matthews' formidable group of Asia experts. The firmwide focus on domestic growth and lesser-known stocks gives investors at Matthews funds a distinct, off-the-beaten-track look at Asian markets.
The conversation has been edited for clarity and length.
Arijit Dutta: About a year ago, there was much talk about decoupling and that emerging markets would escape the crisis. The crisis didn't originate in emerging markets, people argued, and emerging markets now had their own growth engines. In late 2008, both those theories were shot to hell. Yet now it seems like the decoupling argument is arising again. What are your thoughts on this topic?
Arjun Divecha: First of all, the idea of using a single concept called decoupling to encapsulate a whole range of complex issues is very narrow-minded. There is not a single dimension to emerging markets.
Having said that, the way I think of most emerging economies is that they are like a boat with two engines. One engine is export-driven; the other engine is domestic consumption. Clearly, a decoupling to the West and developed markets cannot happen on the export side. If developed markets do not recover, demand does not recover, and the export engine is going to stay broken for a while. On the other hand, we have the domestic consumption. This is where you've seen the new decoupling that people recently have been talking about. Domestic demand and consumption have been stimulated through massive fiscal and monetary spending. It is working as you would expect it to, because for most of these countries, this is not a structural crisis; it is a cyclical crisis. The United States and developed markets, for the most part, have had a structural crisis; they will have to change their financial systems coming out of this. That's not true for emerging markets.
Rusty Johnson: I agree. To say that emerging markets can be completely delinked from developed markets, as big as they are, is just not logical. True, the big economies are slowing and the growth rate of the emerging-market economies is likely to be lower, but they're probably not going to be directly linked. Another aspect that has created this illusion of a complete decoupling is the credit issue. In December, January, February, credit froze up around the world. Nobody knew what was going to happen. Corporates understandably were afraid even in developing economies. This was a period when the developing economies did look like they were plunging with the world. But it was short-lived.
Andrew Foster: Decoupling is not necessarily a desirable state. The biggest emerging markets, like China and India, have grown because they have coupled with the rest of the world. It's the export engine that Arjun was talking about. But it's also very much the fact that these markets open themselves up for business domestically to external competition. It's been that very favorable coupling that's taken place that has powered the growth over the past two decades. True decoupling--what we see in North Korea and Pakistan, where domestic events and politics are so strained that the economies are severed from the world--is undesirable.
Also, building on what Rusty said, the credit hiccup hit emerging markets because their capital markets are just not as deep yet as the developed markets. The bond markets in China and India are really small, especially the corporate bond markets. As a consequence, the pools of capital that could help see these countries through a retrenchment in credit elsewhere in the world essentially dried up. That's why we saw the destruction we did. Capital markets now are picking up steam, which will help emerging markets ride out some of the global shocks in the future.
Dutta: Some of the data coming out of China have been astonishing. We're hearing that a lot of these growth statistics are being driven by investment and government spending and that it's going to create a lot of overcapacity. Do you agree?
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