by Lady Michelle Jennifer Santos
29 January 2016 (TSR) – Fund managers say that there’s a realignment in emerging markets – and the world in general – with services, particularly technology, to the fore and trade in physical goods, especially commodities in retreat.
When IMF managing director Christine Lagarde was asked in Davos in how the economies of the Brics (Brazil, Russia, India, China, SA) are performing in 2016, she gave some interesting detail on the outlook for first four (poor; very poor; great; OK) but never mentioned South Africa.
A similar approach is followed in this piece below from the Financial Times of London where SA isn’t mentioned among the Brics.
These public statements are illustrates an uncomfortable reality – although SA cracks an invitation to the annual gatherings – and is even a formal participant in the proposed Brics Development Bank – for the rest of the world, the Brics end with China.
The Financial Times article argues that troubles in Brazil and Russia have killed the concept of Brics – with Taiwan and South Korea replacing them as global economic drivers. Interestingly, there are no mentions of South Africa in the new Ticks anagram.
Steven Holden, founder of Copley Fund Research, which tracks 120 EM equity funds with combined assets of $230bn, said that Bric, omitting South Africa from the anagram, is not the engine of emerging market growth it was and that there is a new order of things.
It has not worked out quite as planned. The GDP growth rate of China, by far the largest of the four economies, has slowed faster than its boosters expected.
“The Brics concept was based on the belief that the quartet of Brazil, Russia and India and China would power an unstoppable wave of emerging markets-led economic growth, gripped the firmament for more than a decade after it was conjured into existence by Jim O’Neill, then chief economist at Goldman Sachs, in 2001”, the article explains.
“But the deepening recessions in Brazil and Russia have now dealt such a blow to faith in the Bric hypothesis that, late last year, even Goldman closed its Bric fund after assets dwindled to $100m, from a peak of more than $800m at the end of 2010”, the article states.
The BRICS account for a fifth of the world’s economic output and 40 percent of its population.
Russian economy has suffered because of the fall in the global price of oil, its main export, and it has been looking for new markets since relations with the West sank to their lowest point since the Cold War over the Ukraine crisis.
Russia’s increased focus on Asia since the crisis in Ukraine began has brought some successes. China had bought around $1 billion worth of Russian domestic bonds in 2015.
GDP is currently falling in Brazil and Russia, and India’s rosier numbers have been boosted by generous statistical adjustments, Reuters reported in November.
“CRIBs was an early favorite because it put China first –- because, well, China is only reason anyone really cared. No offence to Brazil, India and Russia, which boast plenty of economic merits. BRICs, though, was just a sexily–named vehicle for a bunch of frenemies keen on exploiting each other. Beijing wanted ready access to national resources and help challenging U.S. hegemony; Brasilia, Moscow and New Delhi sought a direct line to China’s deep pockets,” Barrons reported.
The BRICs era is now history, as Goldman attests. As Bloomberg News reported in 2015, it quietly shut its BRICs investment fund last month after losing 21% over 5 years. Its assets lost 88% and declined to $98 million at the end of September after peaking at $842 million in 2010, according to data compiled by Bloomberg.
Due to the Emerging market fund managers appear to have stumbled on its potential replacement – the Ticks, with tech-heavy Taiwan and (South) Korea elbowing aside commodity-centric Brazil and Russia.
“Tech is just rampant and the consumer is what you are investing in EMs now. I don’t think many people are aware of the new EM story as much as they should be. They think of Brazil, Russia, materials, big energy companies. That has changed hugely,” Holden said.
“In many emerging markets the speed with which young consumers are adapting to technological change, in areas such as ecommerce and online shopping, is much faster than in the US”, Richard Sneller, head of emerging market equities at Baillie Gifford, whose EM Growth and EM Leading Companies funds invest 45-50 per cent of their $10bn-15bn of assets in technology companies, adds.
“Trends that we hoped would emerge 15-20 years ago have come to generate significant cash flows.”
“We are seeing leapfrogging [of technology] going on in China. There are models in the west, bricks and mortar etc, that simply won’t happen there,” Luke Richdale, chief client portfolio manager, emerging markets at JPMorgan Asset Management, which manages $70bn in EM and Asia-Pacific equities, said.
Copley’s data above shows the average emerging market equity fund now has a near-54 per cent weighting to the Ticks, up from 40 per cent in April 2013, while the weighting to Brics has remained in the low 40s, despite a sharp rise in China’s index weighting.
As of December, 63 per cent of funds had at least 50 per cent of their assets invested in the Ticks, while only 10 per cent had such high exposure to the Brics.
“Managers are definitely ramping up their technology exposure. The numbers buying and overweight [the index] have gone up. For some funds, the index means nothing,” Holden said.
Almost a third of funds are now overweight Taiwan, up from just 8 per cent in September 2013, Mr Holden said.
Houses such as JPMorgan, Nordea and Swedbank have a weighting of at least 35 per cent to Taiwan and Korea alone in at least some of their funds, while vehicles managed by Carmignac, Fidelity and Baillie Gifford have exposure of 3 per cent or less to Brazil and Russia.
The average EM equity fund now has as much exposure to China’s IT industry as it does to the country’s financial sector, as the second chart shows – despite the index weighting of financials being 4 percentage points higher – following a sharp rise in tech holdings in the past three years.
“To some extent, funds’ buying of Ticks and tech stocks reflects their rising weightings in the MSCI index, particularly with many basic materials and energy companies suffering sharp falls in market capitalisation amid the commodity rout. The four Ticks now have a combined weighting of 62.4 per cent”, the FT states.
One unanswered question is whether this trend reflects an underlying structural change or whether it is purely cyclical, with sectors such as IT and consumer stocks naturally seeing their weightings rise as commodity-related companies go backwards.
Taiwan was the largest country weighting in the MSCI EM index during the dotcom boom of the early 2000s, before the start of the commodity supercycle. Brazil, which led that phenomenon, has subsequently seen its weighting fall from a peak of 17.6 per cent in June 2008 to just 5.2 per cent.
Some of the fund managers say that there is an underlying structural story but at the same time equity markets in emerging markets are quite cyclical in nature.
Three big changes were lurking, though: ideology, demographics and institutions, Reuters said.
The quality of institutions has been gradually improving.
“Prosperity increases if and only if private corporations, government agencies, hospitals, schools, universities and less formal groupings of business people are staffed by competent people who do their jobs reasonably well”, Reuters said.
Institutions in poor countries remain much weaker than in rich ones – consider China’s corruption, or the unwillingness of non-resident Indians to take on bureaucratic roles in their native lands. But even turning terrible institutions into merely bad ones can create big gains.
“As more people in poor countries become more educated, the values and practices which reduce poverty and create wealth become more widespread. As wealth spreads, health and education improve, so the next generation has more to offer than the last. More is invested in physical and human capital. Institutions become stronger,” Reuters report explained.
“The financial crisis slowed progress, causing capital to be withdrawn from emerging markets and commodity prices to fall. Old problems have resurfaced. However, the latest economic predictions from the Organisation for Economic Co-operation and Development, often referred to as the rich country club, show the basic BRIC story remains good”, Reuters said.
GDP for OECD members is expected to increase 2.2 percent in 2016. That is not bad for countries which are already highly prosperous, but it is far below the 4.2 percent predicted for the non-OECD members.
The rate at which the poor are catching up to the rich is slowing, but has been going on for long enough to change the world. The 80-20 of the early 1990s is now more like 85-50 – the 85 percent of the world’s people who live in developing economies consume about 50 percent of total production. The proportion is set to increase in 2016, even if it proves a relatively difficult year for developing countries.
Mr Sneller believes there is a cyclical element and structural factors at play, with some of the consumer-oriented “toothpaste and tractors” stocks, before the Asian financial crises, for instance, online shopping likely to become far more dominant in China than, say, the US.
Analysis by Michael Power, strategist at Investec Asset Management, suggests the trend may be cyclical. All the Ticks (barring India which has a small current account deficit) are in the same quadrant of a matrix he uses to distinguish emerging market countries – that comprising manufactured goods exporters with an external account surplus.
As the fortunes of these quadrants tend to ebb and flow in line with global liquidity and commodity demand, they tend to perform in a cynical and cyclical manner, the FT article explains.
Fund managers say the quadrant inhabited by most of the Ticks “always does best,” in risk-adjusted terms, over an economic cycle, suggesting it should increase its weight over time.
“Whatever the truth of that, the rotation of the MSCI index away from primary industries and towards technology does raise a question as to why emerging market equities are still so driven by sentiment towards commodities”, the FT said.
Last July, the BRICS emerging nations said they were worried about the volatility of global financial markets and oil prices and agreed to coordinate efforts to keep their economies stable.
“We are concerned about the instability of the markets, the high volatility of energy and commodity prices, and the accumulation of sovereign debt by a number of countries,” Putin said.
Chinese President Xi Jinping refrained from comments about the slump, saying only that there are “difficulties” in the global economy, but urged the BRICS to increase coordination.
“Of course, trends need not last forever. Some development economists anticipate that China and other currently successful countries will be caught in middle-income traps. They are right if society cannot evolve along with the economies, so that corruption or social conflicts undermine growth. Then, the stagnation of the pre-BRIC century could return”, Reuters said.