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Emerging markets vs Japan: which offers the most value?

Emerging markets vs Japan: which offers the most value?

Investors in emerging markets and Japan have not had the easiest of rides in recent times. Emerging markets endured a violent sell-off last year as investors fretted about the impact of an end to the US's money-printing 'quantitative easing' process: the MSCI Emerging Markets index fell 4% during 2013, while developed markets posted strong returns.

Japan has meanwhile been a longstanding source of investor disappointment due to the country's stagnating economy. Prime minister Shinzo Abe's economic reform efforts - dubbed 'Abenomics' - have however injected some long-needed optimism. Abe has been introducing massive fiscal stimulus, more aggressive monetary easing from the Bank of Japan and structural reforms to boost competitiveness.

Those efforts have produced positive results from investors, with Japan's Topix index up 24.7% last year. But so far this year, markets have reverted to type, with investors nervous about the impact of the country's recently introduced sales tax.

Here two multi-managers, whose job it is to pick out the best funds for their investors, outline why they are turning respectively to emerging markets and Japan in their quest for returns.

EMERGING MARKETS

John Ventre, who manages £5 billion in multi-manager funds for Old Mutual Global Investors, has increased exposure to emerging markets.

‘We observe an incongruity between the way risk is being interpreted in emerging market assets and the way it is being interpreted in developed market assets,’ he said.

‘We do not think the world has magically decoupled all of a sudden. Emerging markets are still very dependent on developed market growth and vice versa. We live in a global economy. The idea that developed markets are having a recovery that we can all enjoy, while being fearful of a slowdown in emerging markets does not make logical sense.

‘What we have done is to dial back on developed market positions and chosen to take more of a risk in emerging markets. Over a third of our international exposure, or 11% of total exposure in Spectrum 5 [a medium risk fund], is now in emerging markets. That is high, relative to history, but it is high because it is cheap.

‘We accept that there are risks involved, but we manage that risk by being a bit underweight equity overall. We are actually a bit cautious if you look at the overall top-level allocation, but we have chosen to have more of that risk at work in emerging markets.’

But Ventre is not seeking to take on more risk overall. He has decreased his equity exposure in the £614 million Spectrum 5 fund to 45%, one third of which is in UK shares and the rest in global markets.

Ventre said: ‘We have the hatches battened down a little. We try not to make big discrete bets, but it has been a gradual decrease in equities over the latter half of the first quarter and early part of the second quarter.’

Bespoke funds

For broad emerging market exposure, Ventre (pictured) uses the Dimensional Emerging Markets Targeted Value fund along with regional funds tailor-made on an institutional basis for Ventre’s team.

One of such bespoke funds is an Asian mandate run by Citywire AA-rated Robin Parbrook of Schroders, while Christopher Palmer of Henderson Global Investors is running bespoke funds for exposure to Latin America and emerging Europe.

Ventre’s most recent addition is EI Sturdza Strategic Emerging Europe, managed by Citywire A-rated Michel Danechi of Armajaro Asset Management.

Ventre said: ‘It is an Eastern Europe value-style fund. I strongly believe that if you are buying something because it is cheap then you should buy a value manager and not a growth manager.’

Ventre said he saw the Ukrainian crisis as a buying opportunity, both in Russian and in wider Eastern European assets. ‘I think we are past the worst of it. We are analysing Russia at the moment, potentially looking to buy into weakness we have seen. The two real risks in Russia are weak demographics and political risk, in other words whether you trust Putin or not. In our view, both those risk are truly priced in,’ he said.

The Old Mutual Spectrum 5 fund has returned 16.3% over three years and 57.6% over the past five years.

JAPAN

Martin Gray, manager of the £771 million CF Miton Special Situations Portfolio, a global balanced fund of funds, thinks it is difficult to find value overall in the market, and currently has a quarter of his fund in cash.

The only equity market he is cautiously optimistic about is Japan, which makes up 10.9% of the fund, invested in funds such as GLG Japan CoreAlpha Equity fund, managed by the Citywire + rated trio Jeffrey Atherton, Stephen Harker and Neil Edwards, and JP Morgan Japanese Investment Trust, managed by Nicholas Weindling.

Japanese stocks rallied from the onset of ‘Abenomics’ at the end of 2012 until the middle of last year, but have gone sideways in recent months.

Gray said: ‘A lot of people have become pessimistic about Japan. They have run for cover because of the sales tax went up from 5% to 8% at the start of April.

‘Everyone is referring back to the last time when Japan put the sales tax up, in 1997, but you have to remember that a couple of months later the Asia crisis hit and that threw the whole region out. So the comparison is not particularly relevant.’

Corporate profits

Despite growing pessimism among some investors, and cognisant of the fact that his high Japanese exposure has been a drag on performance lately, Gray (pictured) is sticking to his guns on Japan.

‘I might even increase our position. If you look at the historic price-earnings ratio of the S&P 500 of 18 times, then you have 13 times for the Tokyo Stock Exchange Stock Price Index (Topix).

‘I think the outlook for corporate profits in Japan look better than in the US. There are negatives around but I do not think the Japanese economy is in such a bad position. The sales tax will help with the budget deficit,’ said Gray.

‘Return on capital has to improve, and it probably is, and productivity needs to be improved, and it probably is, although slowly. Getting more women involved in the workforce is important and it is happening slowly.’

Gray stressed, however, that the Japanese outlook was not entirely upbeat.

‘There are some concerns, for example Abe’s nationalistic approach in the East China Sea and how that pans out. He does not necessarily want to take on China, but he is not going to step back, that is for sure,’ he said.

Sovereign debt

Meanwhile, Gray is not overly concerned about what is often seen as the number one threat to the Japanese economy: the staggering sovereign debt of more than 220% of gross domestic product.

‘Japan has always managed it and it is in control of it, with around 90% being domestically placed. There is a lot of short-dated stuff as well. I do not think it is a huge problem. It would be if inflation took off, but there are no signs of that happening,’ he said.

CF Miton Special Situations Portfolio has returned 4.2% over the past three years, and 14.4% over the past five years.

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