The world’s developed markets have squeezed out single-digit returns in the past 12 months, but emerging markets are another story, generating double-digit numbers that reflect their stronger economies. Emerging-markets mutual fund managers are upbeat about prospects for these regions, despite some observers raising concerns about a potential bubble caused by significant capital inflows.

“The emerging markets are very hot,” says Mark Mobius, lead manager of Templeton Emerging Markets Fund and executive chairman of Franklin Templeton Investments Corp. ’s Templeton emerging markets group in Singapore. “People are beginning to realize that we are in a situation [in which] these markets are growing three times faster than developed countries. They’ve built up incredible foreign-exchange reserves and have low debt-to-[gross domestic product] levels. They have all their ducks in order.”

Capital has been flowing rapidly into emerging markets, he says, noting that firms based in emerging markets account for 50% of global initial public offerings and secondary market issues.

“There is always a risk of a bubble when you have a lot of money coming into a market,” says Mobius, “but a lot of the new money is being absorbed by the secondary market and IPO activity. Last year, about US$250 billion was raised with IPOs and in secondary markets. This year, it will be more than double that.”

But Mobius does not believe there is a bubble. First, he notes, many institutional funds have not bought into the sector’s story, in spite of the improving fundamentals. “The problem is that most investors are very short [on] the emerging markets,” he says. “These markets represent 32% of global market capitalization, yet they account for about 3%-4% of most institutional funds.”

Second, he says, valuations are still reasonable. Emerging-markets stocks have ranged from as low as one times book value, in February 2009, to three times, in mid-1988. Currently, valuations are at about two times book value.

A bottom-up investor, Mobius does not follow the benchmark MSCI emerging-markets index. As a result, the country weightings in the Templeton fund are due to the stock-selection process and price appreciation. Currently, about 16% of the fund’s assets under management are in China, 15% are in Brazil, 11% are in India, 8% are in Russia and smaller weightings are in markets such as Taiwan.

One top holding in the 100-name fund is Petroleo Brasileiro SA, a.k.a. Petrobras. The largest integrated oil company in Latin America, the firm “has discovered very large and very deep offshore reserves off the coast of Brazil,” says Mobius, noting that Petrobras recently raised about US$70 billion to develop those offshore reserves, estimated to be about 11 billion barrels of oil equivalent.

The American depositary receipt shares are trading at about US$33.20. Mobius has no stated price target.



emerging markets are cur-
rently in a position of strength, says Scott Crawshaw, a portfolio manager who oversees Rus-sell Emerging Markets Equity Pool from London for Seattle-based Russell Investment Group.

“There is a lot of talk about the Chinese currency and what’s going to happen, from a national policy perspective,” he says. “But there is a lot of work to be done in terms of creating more domestic demand and consumer growth within many of these markets to help rectify some of the big global imbalances that we see.”

As consultants and asset managers, Russell has witnessed institutional investors reassessing their emerging-markets allocations. “The trend is for that allocation to increase,” says Crawshaw, who estimates that institutional investors have about 8% of their equities allocation in emerging markets. “In general, [institutional inves-tors] are relatively underexposed to emerging markets relative to market capitalization-based indices. We expect that [allocation] to increase.”

On the supply side, the availability of emerging-markets stocks looks fairly tight, says Crawshaw: “But there is talk of China increasing the free float. The government may sell additional stakes in government-owned companies; as well, private companies may launch IPOs. We also continue to see IPOs out of Brazil and India. As the market grows and we get these IPOs, it becomes easier to accommodate these capital flows, without creating a bubble.”@page_break@In terms of valuations, emerging markets, in aggregate, are trading at a slight discount to developed markets on a forward price-to-earnings basis. Yet, at the specific sector level, such as consumer staples, says Crawshaw, “they are trading at quite a large premium.

“We are not in bubble territory — yet,” he adds. “But the market is trying to build a view of what is justified from a valuation perspective. The fundamentals look stronger: lower levels of leverage and generally high levels of growth. In the short term, there are risks, however, such as potential change in policy regime in some of the larger markets, such as China and Brazil.”

Russell, which employs a multi-advisor approach to reduce volatility, has two subadvisors for the fund: T. Rowe Price International Inc. , based in London; and New York-based AllianceBernstein Investments Inc. The latter team adheres to a deep-value style, whereas the T. Rowe Price team is attracted to sustainable growth stories and leans toward consumer staples and cyclical names.

On a geographical basis, China is the largest weighting in the Russell fund, representing 18.9% of AUM, followed by India (9.3%), Brazil (8.5%), Russia (5.7%).

Running between 100 and 120 names, T. Rowe Price managers favour companies such as Lojas Renner SA. The Brazilian fashion apparel and footwear retailer “has a strong, sustainable growth story,” says Crawshaw, “as the consumer upgrades its basket and these goods become affordable.” The stock trades on a consensus P/E multiple of 26.8 times 2011 earnings, and long-term earnings growth of about 24%.

For its part, AllianceBernstein has about 80 to 90 stocks, and favours names such as India’s full-service Canara Bank. Its shares are trading at 8.1 times 2011 earnings.



since the spring of 2009, the emerging markets have had a sustained rally and are trading at a slight premium to the world, observes Robert von Rekowsky, manager of Fidelity Emerging Markets Fund and vice president at Boston-based Fidelity Investments. Citing a recent Credit Suisse analysis, he notes that emerging markets are trading at 2.06 times book value, vs 1.82 times for the world.

“As long as emerging-markets companies can continue to deliver higher returns on equity, that price/book multiple is sustainable,” says von Rekowsky, adding that emerging-markets firms generate 14.2% returns on equity vs 11.3% for the MSCI world index.

“I’ve never advocated that just because they are emerging markets they should trade at a sustainable premium,” he adds. “In certain circumstances, it makes sense. The developed world’s multiple is somewhat depressed, and part of that relates to the ‘limping along’ state of global financial stocks … many banks are trading at, or below, their book values.”

Backed by a global team of analysts, von Rekowsky is a bottom-up investor who focuses on the best ideas that the analysts come up with. For instance, although the Fidelity fund may have an underweight 7% of its AUM in Taiwan, relative to the MSCI emerging market index’s 10.2%, von Rekowsky likes a few of Taiwan’s technology companies.

Conversely, von Rekowsky has an overweighted 8% position in Russia, vs 6% in the benchmark, because he likes Russia’s banks, materials and energy firms.

The Fidelity fund also has 14% of its AUM in Brazil (vs 16.6% in the index); 8.5% in India (8.2%); and 16.5% in China (16.4%).

Running a 230-name fund, von Rekowsky likes Taiwan-based electronics firm HTC Corp., which makes handheld computers as well as smartphones for clients such as Google Inc. HTC was beaten up in the autumn of 2008, but has rebounded since. “It has more markets to go to and come up with more solutions,” he says. “This could be a multi-year story.”

HTC stock is trading at about T$691 ($23), or about 11.5 times 2011 earnings. IE