Over recent years, many investment categories have increased strongly in value, partly due to low interest rates. A number of categories, including US equities and many fixed-income categories, could now be considered overpriced. Investors can respond to this in several ways, for example by allocating more to illiquid investments. Attractive alternatives in other investment categories could also be considered. For example, in terms of equities we see emerging markets as having a relatively favorable outlook.
Relative valuations of equities
The relatively favorable outlook for emerging market equities is based on relative valuations of various equity markets. Although it is virtually impossible to predict stock markets in the short term, the Shiller Price-Earnings (PE) ratio is one of the best indicators for long-term equity returns. This indicator is based on the ratio between the current stock price and inflation-adjusted profits over the previous ten years. The ratio can be used to determine the value of equities relative to historical values and to identify differences between regions.
Favorably priced equities in emerging markets
The Shiller PE ratio highlighted considerable differences between regional equity markets at the end of the first quarter of 2018. The value for the United States was 29.8 compared with 24.7 for developed markets and 17.2 for emerging markets. Although these ratings are well below the values seen before the dot-com crash in 2000, they are higher than just prior to the financial crisis in 2007. Current valuations are at a level where, historically, corrections have taken place.
Relative valuations should be considered in context. For example, historically, stocks in the United States have had a higher valuation than stocks in other regions. But even if this is taken into consideration, the conclusion that equities from emerging markets are favorably priced compared to equities from developed markets still holds true.
Emerging Markets fund combines regional and worldwide mandates
The TKPI MM Emerging Markets Fund provides a vehicle to leverage opportunities offered by equities in emerging markets. The fund invests through mandates with selected external managers. This results in a unique combination of regional mandates on the one hand and global mandates on the other. This means that investors not only benefit from regional expertise but also from trade-offs between companies in different regions.
Long term investments in quality companies
Our strategy is primarily to invest for the long term in companies that are able to achieve strong results despite changing market conditions. The turnover rate in the fund is therefore low, which means that transaction costs are kept to a minimum.
Portfolios managed by external managers are concentrated around a relatively small number of companies. This is based on the belief that it is better to reduce risk by investing in companies that you know inside out, rather than spreading investments over a larger number of lower quality stocks. By combining several managers in the fund, an optimal risk-return ratio is achieved.
The results achieved by the fund so far have been outstanding, with annual returns of more than 8% over the past 10 years. It has also outperformed the index by more than 3% per year.
In many regions, stocks are currently overpriced, particularly in developed markets. Based on the Shiller Price-Earnings ratio, however, equities from emerging markets – home to a significant proportion of global economic growth – are more favorably priced. This offers opportunities for investors, particularly if regional mandates are combined with worldwide mandates, as we do for the TKPI MM Emerging Markets Fund.
Authors: Sibrand Drijver, Senior Investment Strategist, and Anton Kramer, Senior Portfolio Manager Emerging Markets