Emerging markets offering bigger returns

Investors find bonds with plumper yields, and stocks that beat the S&P; 500

By Trevor Hunnicutt

May 25, 2015 @ 12:01 am EST

Michael Morgenstern

A slowdown in Chinese economic growth, a pullback in Indian stock prices and the Damoclean sword of U.S. monetary policy are hanging over emerging markets.

But that isn't stopping Chad White, president of Safe Harbor Wealth Management Inc., an LPL Financial affiliate in Toms River, N.J. Earlier this month the adviser moved a sizable chunk of his clients' portfolios from bonds to exchange-traded funds tracking stocks in Europe, China and India.

“This is the first change we've made” in a while, Mr. White said. “We didn't have any trades last year.”

Investors this year have already poured $16.3 billion into mutual funds and ETFs tracking emerging markets stocks and bonds, as well as those tracking China and India specifically, according to Morningstar Inc.

On balance, those investors are finding bonds with plumper yields than their miserly counterparts in the developed world. They're also finding stocks that beat the 3.4% delivered by the S&P; 500 so far this year, a tepid figure compared with the six-year bull market that regularly posted yearly gains topping 15%.

Diversified emerging-markets funds are up an average 7% this year as of May 18, according to Morningstar. And emerging-market bond funds have paid an 81-basis-point premium over the intermediate-term bond funds favored by retail investors.


“With continuing low U.S. investment-grade yields, investors have sought better yields in other countries, among other places, and emerging markets can serve that purpose,” said Paul Christopher, head of international strategy at the Wells Fargo Investment Institute, a research group serving the San Francisco-based bank's 15,000 financial advisers, who manage $1.7 trillion. “They've been one of the destinations of choice. They've attracted a lot of flows.”

Underneath the headline numbers, however, are countries taking divergent paths. For instance, after leaping 30% last year on hopes of business-friendly reforms, the India-tracking S&P; BSE Sensex benchmark is down 2% so far this year, as of May 12.

Yet economic growth is now greater in India than in China, where a high-flying stock market seems, to some professional investors, inconsistent with the short-term prospects of the world's second-largest economy. The Shanghai Stock Exchange Composite index has returned a stratospheric 114% over the last year.

“It's a classic speculative bubble. But that speculative bubble has been given fuel by the easing policies in China,” said Peter Taylor, senior investment manager on the global emerging-markets equity team at Aberdeen Asset Management, an Aberdeen, Scotland-based fund house that manages $491 billion.

China has cut benchmark interest rates three times in six months. But if U.S. growth ticks up, that may force the Federal Reserve to raise rates aggressively, which could throw a monkey wrench in the works of emerging markets. Extremely easy monetary policy in the U.S. is seen as supporting countries dependent on foreign investment.

With continuing low U.S. investment-grade yields, investors have sought better yields in other countries, among other places, and emerging markets can serve that purpose.

“The Fed could easily be the driver of the three- to six-month outlook” for emerging-markets stocks and bonds when they raise rates, according to Mr. Christopher.

But analysts caution that the impact of rising U.S. rates could be felt differently across emerging-markets countries — Brazil, Russia and Mexico, among them — that are more or less economically dependent on factors such as exports, commodity prices and the extent of state-controlled enterprises.

And despite the recent pickup in performance, emerging markets have a lot of lost ground to make up. Companies in those countries have delivered “virtually no earnings growth” over the last five years, according to Charles E. Knudsen, an equity portfolio specialist at T. Rowe Price Group Inc., which manages $773 billion.


But many of the trends in the markets are positive, including government reforms and the fundamentals of some companies.

Mr. Knudsen and Mr. Taylor agree, for instance, that a number of Indian companies are exceptionally well-run. Both the Aberdeen Emerging Markets Fund (GEGAX) and the T. Rowe Price Emerging Markets Stock Fund (PRMSX) hold large stakes in India's Housing Development Finance Corp. and Infosys.

And they remain confident in the reformist agenda of Prime Minister Narendra Modi, who took office last year and is seen by foreign investors as slicing government red tape and investing in infrastructure.

Those factors are among the reasons keeping Mr. Knudsen optimistic about emerging markets, which he says are underrepresented in benchmarks and investor portfolios.

“There's been a little bit of a hiccup,” Mr. Knudsen said. “We still believe in the long-term secular outlook,” including the increased urbanization of their populations. “Growth in the emerging market will be faster than in developed markets.”

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