Fund manager interview series

Emerging markets offer interesting opportunity

Mr Aymeric Forest says investors in emerging markets not only need to diversify, but must also be selective, stressing the need to distinguish between those companies that are over-reaching to pay dividends and companies that have the ability to sust
Mr Aymeric Forest says investors in emerging markets not only need to diversify, but must also be selective, stressing the need to distinguish between those companies that are over-reaching to pay dividends and companies that have the ability to sustainably grow their payouts.PHOTO: GIN TAY FOR THE STRAITS TIMES

Aymeric Forest, Schroders' head of multi-asset investments, Europe, discusses his outlook on a multi-asset income approach and emerging markets in the latest in our series featuring fund managers.

Based in London, Mr Aymeric Forest joined Schroders in 2011. His focus is on complex segregated mandates and on enhancing the firm's approach to tactical asset allocation.

Before joining Schroders, Mr Forest was head of global investment solutions at BBVA in Madrid and responsible for multi-asset products such as individual and corporate pension funds, balanced and dynamic asset allocation solutions and life-cycle funds.

As at Nov 30 last year, Schroder ISF Emerging Multi-Asset Income achieved an annual return of 11.7 per cent (bid to bid) since its launch in April 2015.

Q What does Schroder ISF Emerging Multi-Asset Income offer investors?

It is a solution from our multi-asset income range designed to take advantage of growth and income opportunities in emerging markets. It combines two important features for investors - a regular source of income, and a diversified and flexible emerging market investment solution.

Emerging market assets provide a natural source of high yields at a time when investors face the challenge of low nominal interest rates. However, we think investors need to use a flexible and selective approach when investing in these markets.

This is because traditional approaches based on indices such as MSCI EM Equities or JPM EMBI+ can be concentrated, generating significant exposures to a small number of countries. There can also be wide divergences in performance across and within emerging market asset classes.

The fund can be seen as both a core holding within an emerging market portfolio, or as a superior risk-adjusted way to access emerging markets.

While there are attractive returns available, emerging markets tend to be more volatile than developed markets. We therefore believe that a strategy which is diversified and actively managed across both asset classes and countries can help to reduce the volatility associated with investing in this area of the market.

Q How is Schroder ISF Emerging Multi-Asset Income different from other emerging market funds?

A Our approach differs from the competition in three ways. The first is income generation. The fund provides a regular income, targeting 5 per cent per annum with a volatility target of 8 per cent to 16 per cent.

Second, the fund actively differentiates between asset classes and currencies. We use a dynamic asset allocation process as well as the bottom-up expertise of our security specialists.

The third differentiating factor is the risk management approach, where we use our investment research to remove any unwanted risks or to identify relative value opportunities.

Q What are the advantages of taking a multi-asset income approach to emerging markets?

A Over the last 10 years, emerging market bonds and equities have either been among the best or the worst performing asset classes each year. This highlights the strong return potential of these asset classes, but also the high associated risks.

Investors in emerging markets not only need to diversify, but must also be selective. As a result, we believe that an actively managed, multi-asset solution is an attractive way to gain exposure.

We believe that emerging markets present an interesting opportunity for those seeking income-generating alternatives within their portfolio. Emerging market assets are attractively valued and offer higher yields than developed markets.

Within emerging markets, high-yielding equities tend to be cheaper than the broader index and may indicate better quality and profitability prospects as companies require strong enough balance sheets to be able to pay out dividends. However, we have to distinguish between those companies that are over-reaching to pay dividends and companies that have the ability to sustainably grow their payouts.

Q Why should investors consider emerging markets?

First, there are some supportive structural arguments. Emerging market economies own more land and resources, and have higher potential gross domestic product than developed economies. The International Monetary Fund also expects to see an additional one billion middle-class consumers in these economies over the next 15 years.

Second, emerging market assets are attractively valued. Equities are priced at approximately 1.5 times their book value compared with three times for US equities, while both local currency and US dollar-denominated emerging market bonds offer attractive yields.

Finally, emerging market assets have been under-owned since 2012. Flows are now slowly turning positive. Emerging market-related assets could benefit from an increasingly positive growth rate compared with developed economies and from the search for yield given their relatively attractive yield-to-volatility ratios (that is, the level of yield received for each unit of risk).

Q What are the specific sectoral opportunities in emerging markets?

A Within equities, our preferred markets are South Korea and China. Korean equities are trading at a significant discount to the broader emerging market universe and offering double-digit earnings growth, while we believe China is under-owned and offers the potential for earnings growth.

In terms of fixed income, we favour local currency bonds over US dollar bonds. Falling inflation provides some scope for rate cuts, which should benefit local bonds, while real yields are attractive compared with the US.

Q What are some of the risks investors need to be aware of in emerging markets?

While there are attractive returns available, emerging markets tend to be more volatile than developed markets. We therefore believe that a strategy which is diversified and actively managed across both asset classes and countries can help to reduce the volatility associated with investing in this area of the market.

In addition, the volatility provides a wide opportunity set due to inefficiencies within these markets. It is also important to understand the individual drivers of each market, including the global and domestic economic backdrop, and the local and global political environment.

Q How are emerging markets impacted by the uncertainties in the West?

Emerging market assets have been supported by accommodative monetary policies in the West, as well as the weaker US dollar. If this were to reverse, it would be negative for emerging market assets. However, we believe the path of policy normalisation should be gradual and this should also help keep the US dollar relatively weak. It is also important to note that emerging market countries are generally in a better position from an external vulnerability perspective than previous episodes of stress associated with tightening, such as the "taper tantrum" in 2013.

Emerging market assets have also been impacted by uncertainty over US trade policy since President Donald Trump's election and his protectionist rhetoric. Although the immediate threat has subsided, it is crucial to analyse how any changes will impact individual markets.

For example, some export-reliant manufacturing markets such as Mexico could be negatively impacted, while more Europe-focused markets such as Poland and Turkey are likely to be less exposed to any US protectionism.

Q How do you limit downside risk during adverse market conditions?

Managing risk is critical to minimising drawdowns. Besides attempting to maximise the diversification of our portfolio, there are periods where correlations between asset classes increase. This is why we also use a dynamic asset allocation approach, analysing various market risks within the fund and then potentially reducing equity, currency and/or interest rate risks as required.

Q What is your investment advice for the Asian investor this year?

A Given the synchronised expansion of the global economy and favourable corporate profits, we remain bullish on equities and prefer emerging market assets in both equities and fixed income.

We expect to see some convergence between growth and income stocks this year. We like the high-quality nature of the US market with its strong earnings momentum, which may be boosted by the government's tax reform. Emerging markets continue to be another hot spot that offers attractive valuations and strong growth prospects.

On fixed income, we maintain our preference for emerging market debt. As rates start to rise, we become more selective, rotating some of our emerging market US dollar bond exposure into shorter dated sovereign bonds and high-quality emerging corporate bonds, which offer an attractive yield with a lower duration. We should also start to see more opportunities in US investment grade credit.

Nevertheless, as the economic cycle is entering its later stages, we start to become progressively more cautious this year.

Q What keeps you awake at night?

The risk of policy mistakes from central banks or governments.

Q If you were not an investment strategist, what would you be?

A I would probably still be doing something related to economics or finance; after all, having been in this field for the past 25 years, I'm pretty certain it is running in my blood!

A version of this article appeared in the print edition of The Sunday Times on January 07, 2018, with the headline 'Emerging markets offer interesting opportunity '. Print Edition | Subscribe