Opportunities lie within emerging market problems
Developed markets had a satisfactory quarter while emerging markets struggled. Nonetheless, we remain fundamentally positive about the latter and sees clear signs of improvement ahead.
Global equities continued their recent trajectory in the third quarter and delivered satisfactory gains, largely driven by strong and relatively benign developed markets, particularly the US. Emerging markets again posted losses, albeit reduced from the second quarter, as volatility rose across countries and sectors.
Most of our equity funds delivered solid absolute returns over the quarter. The exception was SKAGEN Kon-Tiki which was hit particularly hard as emerging markets were buffeted by a number of macroeconomic factors. Most prominent was the escalation of US trade restrictions, particularly against China where concerns over their impact on the country’s economic growth intensified. This weighed on investor sentiment towards the developing world more generally. An increasingly strong dollar, boosted by rising US interest rates, has also hurt many emerging market countries, particularly those with high levels of foreign debt.
For countries experiencing political turmoil, such as Turkey and Argentina, these economic headwinds have been felt even more acutely. Turkey has been hit particularly hard, with the lira depreciating over 40% and domestic equities losing more than half their euro value year-to-date. Although Turkey is relatively small in terms of economic weight and market capitalisation – it represents less than 1% of the MSCI EM index – concerns have grown that the Turkish troubles could spread across other weakened emerging markets.
While we recognise that Kon-Tiki’s overweight exposure to Turkey has contributed to its underperformance, we are taking steps to address this. Nonetheless, we do not share investors’ fears of broader contagion and remain fundamentally positive about emerging markets. They remain forecast to grow twice as quickly as developed ones over the next two years, have on average half as much debt, and their longer-term drivers of structural expansion and prosperity remain intact. We also continue to believe that their heterogeneous nature and attractive valuations, particularly relative to many developed markets, provide opportunities for investors. This is especially true for active managers with a long-term investment horizon like ourselves.
The US dollar currently looks overvalued on several different metrics and any depreciation would likely boost emerging market fortunes. Meanwhile, it is also possible that President Trump may soften his hard-line stance on trade as tariffs on US exports start to hurt America, particularly ahead of important midterm elections. A reversal in the two most significant headwinds faced by emerging markets this year could hasten and accelerate their recovery.
Developed market momentum
In keeping with the good weather seen across much of Europe and America over the summer, the picture was considerably brighter for developed markets in the third quarter, particularly in the US where equities posted their strongest three-month returns for five years. We continue to see comparatively healthy fundamentals in most regions across the globe and note that companies remain cautiously optimistic about the outlook. Despite high valuations, relative to both historic levels and emerging markets, our portfolio teams continue to find pockets of value and have made several exciting new investments during the quarter. Read more about them in the funds' quarterly reports.
Finally, this quarter marked the tenth anniversary of the financial crisis, a time of unprecedented turmoil and uncertainty for investors. In keeping with markets generally, our clients have enjoyed significant gains in the decade that’s followed, albeit with some turbulence along the way. As monetary policies around the world continue to normalise, we are hopeful that successful stock-picking will be increasingly rewarded. The anniversary also underlines the benefits of remaining calm and maintaining a long-term perspective. With our continued focus on selecting the strongest companies from across the globe at the most attractive prices, I am confident the future should be similarly rewarding.