Global turmoil opens opportunity in emerging market stocks

Global fund managers’ allocations to emerging equity markets are at their lowest levels on record. But a survey of fund managers found that a contrarian rally might be approaching, with most EM stocks undervalued.

A new report by Bank of America-Merrill Lynch, “EM: Most Unloved Ever”, suggests that from a position of strength five years ago, emerging markets have become the biggest risk to global financial market stability.

In particular, foreign exchange and political turmoil has seen the Association of South-East Asian Nation positioning deteriorate to the lowest levels since December 2009.

India is one of the developing markets bearing the brunt of the changed dynamics, with many fund managers going underweight on the country. With the exception of China, its other partners in the BRICS (Brazil, Russia, India and China) grouping are also susceptible to an economic reversal at this delicate juncture. The progressive taper of the quantitative easing programme by the US Federal Reserve is one of the primary factors behind concerns over flight of capital from emerging markets.

In the second half of 2013, currencies of most emerging markets went into a free fall against the dollar, plummeting to record lows. It was only through some deft manoeuvring by the RBI that a crisis was averted in India and the rupee stabilised at a new plateau of ₹62 a dollar.

The top sectors for investment in emerging markets are construction, healthcare and technology, according to BoFA-ML. The report indicates that healthcare stocks witnessed the largest increase in positioning by fund managers in February. In contrast, financial stocks saw the largest decrease. The managers were also bearish about other classic defensive sectors and cut overweight positions on cyclicals.

Furthermore, the report suggests that fund managers reallocated some of their funds parked in industrials and tech in favour of staples and pharma.

In February, South Korea was the top choice of investors looking at Asia-Pacific assets, followed by Taiwan and China. India, Indonesia, Malaysia and Thailand were judged less attractive, according to the survey, which indicated that most investors will keep away for some time.

The report also indicates that investor frustration with the corporate sector is mounting, with 69 per cent of the respondents to BoFA-ML’s survey asserting that firms are “under-investing.” The report warns that until corporations reduce high cash levels, investors will do the same and global equity corrections will be extremely limited.