Selectivity needed in emerging markets

The emerging-market universe is a disparate one offering a wide range of investment opportunities. While there are some unifying factors, the year ahead is likely to continue to be characterised by continuing divergence between emerging markets.

This will present us with some fundamental challenges, but also some opportunities better than we have seen for some time.  Our favoured markets are those of countries that continue to adopt market-friendly growth strategies, remove obstacles to doing business effectively, tame inflation and gain credibility.  We also favour economies that are natural extensions of developed markets, such as Mexico of the US and Hungary of Europe. Both of these countries benefit from their neighbours’ recovery in growth and activity.

ESG going mainstream

We believe that 2016 will be the year that environmental, social and governance (ESG) factors will move centre stage for many investors and be seen as a driver for long-term value creation. Japan is an example of a country that is going through a programme of governance reforms sending encouraging signals to shareholders. South Korea is another.

Meanwhile the scandal at Volkswagen underlined the poor governance of the carmaker in terms of its voting structure and, more importantly, its board composition. The UN Climate Change Conference in Paris (COP 21) has further reiterated that environmental issues are increasingly a mainstream concern. The idea that sustainability should be a pillar of sound investing is not new but as the German economist Professor Rudi Dornbusch wrote “things take longer to happen than you think they will, and then they happen faster than you thought they could”.

Diverging monetary policies

Having delivered an economic recovery, the US is in a position to raise the cost of money. Europe, however, remains at least three years behind this stage, having only just started to run down private-sector debt. Asia, and China in particular, are nowhere near this stage and their debt to gross domestic product ratio is still high, suggesting monetary policy will need to be easy for several years to come. We believe this divergent monetary policy highlights the need to dynamically manage currency exposure to manage down-side volatility and capture opportunities when presented.

The need for portfolio resilience

More than ever investors are confronted by a world that appears full of potential pitfalls. Consequently, investors are increasingly demanding robust portfolios that can outperform the market in challenging environments and are resilient in the face of unforeseen events. Portfolio construction needs to balance the trade-offs between potential‎ returns and risk exposure, and ensure a level of diversification that is robust and appropriately adaptable to an unpredictable backdrop. A vital consideration is the durability of the underlying cash flow generation of company business models, and avoiding areas at risk of disruptive change is key. Portfolios also have to limit exposure to the least liquid parts of the market and have strategies to deal with bouts of market stress.

Finding bottom-up opportunities

In 2016, we believe the investment environment will provide a more supportive backdrop for truly active, bottom-up, skilled stock-picking compared to that of recent years. The return of stock-specific opportunity, falling correlations and slowly increasing interest rates will all contribute to this.  We believe that taking a bottom-up approach (not just to equity investing) is vital to counteract the short-term macroeconomic noise and commentary that can cloud investor judgement.

Philip Saunders is co-head of multi asset at Investec Asset Management

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