Fo
or media distrribution. Apriil 2014
Schro
S
oderrs
Multi-A
M
Asset Insigh
hts
By
y Johanna K
Kyrklund and
d Urs Duss, Fund Mana
agers, Multi--Asset
Va
alue in emerrging marketts, but conc
centrated
Em
merging markket equities have
h
had a difficult
d
time o
over the last few months.. In USD term
ms, the 12 month
m
return to
t
31 March 2014
4 for the MSC
CI World inde
ex was 19.7%
% compared to -1.1% forr the MSCI E
Emerging Markets index. As
nd manager ssentiment ha
as turned exttremely nega
ative according to surveys such as thee BAML Global Fund
fun
Ma
anager, the q
question becomes whether this pessim
stment opporrtunity.
mism offers a good inves
A cursory
c
exam
mination of cu
urrent valuattions would ssuggest that emerging market equitiees are inexpe
ensive both
relative to theirr own historyy and also US
S equities. Ba
ased on the historical relationship beetween valuation and
2 month returrns, EM equities as a who
ole are appro
oaching histo
orically attracctive levels and
a therefore
e
subsequent 12
e significant returns
r
in 2014.
could generate
pon closer sccrutiny, howe
ever, it becom
mes apparen
nt that there are
a particularr themes thaat are domina
ating
Up
valuations. Figure 1 shows the majority
y of the value
e derives from
m Investment and Comm
modities, whils
st on the other
de of the spectrum, Manu
ufacturing and Consumpttion are price
ed expensive
ely relative too their history
y. Within
sid
Inv
vestment, the
e value reallyy lies in Chin
nese financia
als whilst with
hin Commodities it is founnd within Russian energyy
sto
ocks. Conseq
quently a possition in broa
ad emerging markets bas
sed on valuattion is, to a laarge extent, taking a view
w
on these particcular themes.
Fig
gure 1: EM P//B valuations relative to MSCI
M
EM
1.80
1.60
1.40
1.20
1.00
0.80
0.60
2004
2006
2008
2010
EM Consumption
EM Invesstment
EM Commodities
S&P 500
2012
2014
EM Manufacturing
Sou
urce: Schroders, B
Bloomberg, April 2014
2
The current divvergence in the
t fortunes of
o the BRIC countries hig
ghlights the need
n
to conssider emergin
ng markets in
n
ore targeted fashion rathe
er than as a single bloc. Russia is the
e most attrac
ctive based oon value and fundamenta
als,
mo
but despite the
e recent sell-o
off remains dominated
d
byy the political risk premium. Brazil offe
fers little rewa
ard in terms of
n or momentum with the continued do
ownward earrnings revisio
ons. Elsewheere the signs
s are more
either valuation
om China an
nd India. In th
he former the
e mini-cycles
s of stimulus and tighteninng offer tactical
encouraging fro
e-balancing g
growth and deleveraging
d
, whilst in thee latter there
e is some
opportunities during the triccky road of re
omentum witth the cheape
er currency, improved cu
urrent accoun
nt deficit and anticipation of the election.
mo
As
s a result, we
e consider tha
at the curren
nt opportunityy is greatest in Asian eme
erging markeets. 30% of the MSCI EM
M
As
sia is from Ch
hina, whilst another
a
44% consists of T
Taiwan and Korea;
K
counttries we favoour due to the
eir robust
fun
ndamentals a
and participa
ation in globa
al growth.
Th
he credit cyc
cle – enterin
ng the stability phase?
Aftter a very strrong run through 2012 an
nd 2013, retu
urns are likely
y to be restricted to the ccarry available (the intere
est
earned) in 2014
4. Although the
t consensu
us is that valluations are now looking stretched, thhe more challlenging
en should we
e be position
ned more neg
gatively towa
ards corporattes. It can bee difficult, how
wever, to
question is whe
pre
edict the dire
ection of spre
eads and indeed they havve long been
n used as effective leadinng indicators within
eco
onomic and trading mode
els for other markets.
Fig
gure 2: The crredit cycle
Sou
urce: Schroders, M
Morgan Stanley, March
M
2014
On
ne way to approach this challenge
c
is by
b analysing
g the credit cy
ycle to try an
nd establish w
what might trrigger a
correction in va
aluations. Th
he credit cycle tracks the expansion and
a contractio
on of accesss to credit ove
er time. Figu
ure
edit cycle wh ich can be divided into th
hree parts. T
The downturn
n is the most
2 illustrates a sstylised version of the cre
painful phase ffor corporates as the rece
ession hits a ctivity and de
efaults increa
ase, with thee recovery ph
hase
aracterised b
by balance sheet repair. This then pre
epares the way
w for the ex
xpansion phaase of the cy
ycle when the
ere
cha
is increasing
i
co
onfidence an
nd corporate lending resu
umes.
Cre
edit spreads can help us understand where we arre in the cred
dit cycle. Pha
ase 1 (the doownturn) is when
w
spreadss
are
e widening. T
To compensa
ate, central banks
b
cut rattes as the ec
conomy is experiencing a slowdown or
o in recessio
on.
Ph
hase 2 (repair/recovery) iss when sprea
ads are tighttening as the
e economy moves
m
out of recession an
nd in to
rec
covery mode
e. Phase 3 (e
expansion) is
s characterise
ed by spread
d stability with investors bbenefiting fro
om carry rath
her
tha
an capital appreciation.
Fig
gure three sh
hows a quanttitative identification of th
hese three sttages for US high yield annd identifies that US high
h
yie
eld debt is cu
urrently in phase 3 which is the expan
nsion phase.
Fig
gure 3: Phase
es of the cred
dit cycle – US
S HY
Sou
urce: Thomson Da
atastream, Schrod
ders, March 2014. Note: ML HY corpporate spreads arre comparing the corporate
c
bond wiith a US treasury bond of a similar
dura
ation to proxy for O
OAS given data limitation (i.e. HY uses
u
a 5-year bondd). Credit cycle ph
hases are identifie
ed quantitatively uusing a Markov mo
odel.
If we
w consider tthe credit cycle alongside
e the businesss cycle and
d the interest rate cycle, thhere are certain
cha
aracteristics that we wou
uld normally expect
e
to see
e prior to a deterioration
d
in spreads. W
We would ex
xpect the
business cycle to show sign
ns of contrac
ction and inte
erest rates to
o be tightenin
ng. Howeverr, at present corporate
c
b in good sh
hape showing
g signs of recovery and interest ratess have yet to rise.
balance sheetss appear to be
storically we have seen phase
p
3 of th
he cycle perssist beyond th
he first rate rises
r
and as a result we might
m
conclude
His
tha
at we could e
expect two to
o three years
s of stable sp
preads. Howe
ever, while th
his conclusioon may be drrawn from
his
storical trends, there is no
o precedent for
f the curre nt level of qu
uantitative ea
asing and ulttra-low intere
est rates and as
a result
r
we rem
main cautioussly positioned
d and watchfful for any sh
hift in investo
or sentiment triggered by a change in
inte
erest rate po
olicy.
Fo
or further infformation, please
p
conta
act:
Be
eth Saint, Hea
ad of Channel PR - Tel: +44
+ (0)20 76
658 6168/ elizabeth.saintt@schroderss.com
Es
stelle Bibby, E
European Insstitutional - Tel:
T +44 (0)20
0 7658 3431/ estelle.bibb
by@schrodeers.com
Ch
harlotte Bankks, UK Interm
mediary – Tell: +44 (0)20 7
7658 2589/ charlotte.ban
c
nks@schrodeers.com
Ka
athryn Sutton
n, International – Tel: +44
4 (0)20 7658 5765/ kathry
yn.sutton@schroders.com
m
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