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Eastern Europe more attractive than India and China
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China still not good value - even if less overbought
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Russia still cheap but could be a candidate for profit taking
Below, James Smith, manager of the €194m Ignis International Emerging Markets Select Value Fund, gives his view on a number of key emerging markets, explaining why he currently prefers Eastern Europe to the more vaunted BRIC countries.
His views are expressed in terms of key overweight and underweight positions, which have been selected using Ignis' proprietary MASAM (Market and Sector Allocation Model) quantitative screen. The screen ranks in order of preference the 21 countries in the MSCI EM Free Index and six other countries, a combination of recently promoted ‘developed market' countries (Israel, for example) and ‘frontier' level countries like Argentina. James then applies his own judgment to the rankings, and invests on a high conviction basis in countries via index futures and tracker funds rather than to individual stocks.
Key underweights
"We are currently underweight all the BRICs except Russia. In our view, China is still not good value even if it is less overbought."
India
"We have little exposure to India. India was very overblown at the end of 2010 and the market was too bullish - multiples were simply too expensive. Although the market has since sold off, Indian stocks are hardly cheap and the country still faces big inflation problems, although the tightening cycle is now in train. The big question is: can India tighten without hitting its economic growth? The jury is still out on that question, so while we will maintain our low exposure (against a benchmark weight of 7.0%) for the time being, we may look to add some positions - if the market sufficiently de-rates over the coming months."
China
"The market often gets confused between GDP growth and stock market performance and China is a classic case of that. For value investors like us, the sweet spot comes when the prospects for corporate earnings growth look good at the same time that valuations are cheap. Chinese companies, on the whole, remain overvalued, although after the recent fall in the market they are more attractively priced than they have been for some time.
"While more attractive than India, China is not yet sufficiently compelling on any measure to warrant an overweight position and we are currently 2.5% underweight. That has come down a long way from our 10% underweight last year but, while we believe China will have a soft rather than hard landing, for now there are better opportunities elsewhere."
Brazil
"Brazil is a market to which we have increased our exposure recently to a small underweight. As with China and India we recognise the long-term growth potential for Brazil, but quite simply the market had got ahead of events and stock prices were too high for our liking."
Key overweights
Israel
"Although this is no longer technically an emerging market, we still continue to screen it. Israel has been neglected by global funds, in large part because of the move from ‘Emerging' to ‘Developed' market status, and the sentiment in the Middle East has not helped its cause. Because of this the market has become very cheap. It is attractively priced, the fundamentals are reasonable, and it has been overlooked by investors, all things that appeal to us. We have a 4.0% overweight position to it."
Eastern Europe
"We have a big overweight position to Eastern Europe. Last year, countries such as Poland, Hungary and the Czech Republic were shunned by investors, largely due to the despondency surrounding the sovereign debt crisis and the fiscal problems facing certain countries in the region. While we never doubted the dangers, we felt valuations more than compensated for the risk - P/E ratios were between 9 and 11 times 2011 earnings.
"Poland and the Czech Republic in particular have good earnings growth and we are around 5.2% and 5.3% overweight respectively in these countries."
Argentina and Egypt
"Egypt was cheap even before the uprising and we estimate it is now 20-25% undervalued. We added to the position a few weeks ago (we are now 4.3% overweight) and, although it is hard to gauge the impact on economic growth of the crisis - both corporate earnings and GDP will be revised downwards - recent share price activity suggests that the market has already begun to discount this, and we do not believe the end result will be as bad as the consensus fears.
"Argentina is one of the fund's biggest overweights at 4.9% over the benchmark. Argentina has two things going for it: extremely strong GDP growth expected to be more than 6% this year and a market trading on a P/E multiple of 9. It is a market that has done very well for us and, while we have seen a recent period of consolidation, we will continue to hold it due to strong underlying valuation support."
Russia
"Last year Russia was a screaming buy on valuation grounds, although it is now less so. Nonetheless, it is possible to buy stocks in Russia trading on P/Es of around 7-8 times earnings; still very cheap, although they have risen recently due to higher energy prices.
Russia might be a candidate for profit taking in the coming weeks and months although we will see how the market performs."
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