Why it’s time to diversify your Emerging Market exposure

The valuation divergence between value and growth stocks in the emerging markets has reached an extreme, surpassing previous peaks seen during the technology bubble and the Global Financial Crisis. We believe that today’s record valuation dispersion highlights the significant opportunities available to investors, as well as the risk to existing growth-biased emerging market portfolios.

Much has been written about the unprecedented impact of the coronavirus pandemic – the depth of the economic contraction, the swiftness of the market correction as well as the unparalleled monetary and fiscal response of the policymakers. However, the extraordinariness of the situation does not stop there. Investor fears arising from the pandemic have exacerbated the divide between growth and value stocks within the emerging markets, creating an exceptional valuation gap. The valuation difference between growth and value stocks, on price to earnings terms, now far surpasses previous peaks seen during the technology bubble and Global Financial Crisis. See Fig. 1.

Fig. 1. EM Growth relative to Value

wh-i-chart-01

In fact, the most expensive 20% of the stocks within the MSCI Emerging Markets Index is now 3x pricier than the cheapest 20% of the stocks within the index - a valuation dispersion not seen in the last 20 years. See Fig. 2.

Fig. 2. Valuation dispersion within the Emerging Markets

wh-i-chart-02

Any discussion on the valuation dispersion between growth and value stocks invariably leads to criticism that certain valuation metrics such as price to book value are now obsolete as the intellectual property, brand and marketing positioning of dominant technology companies do not exist on balance sheets unlike hard, tangible assets. We agree. That is why we do not rely on a single valuation method. We consider signals, both absolute and relative from a range of valuation measures including price-to-earnings (PE), price-to-book (PB) and dividend yield (DY).

Paying the price

We are not suggesting that many of the growth companies that have outperformed are not good businesses. Many of the sectors or sub-sectors that have led growth stocks’ ascent are likely to benefit in the new normal post-covid – ecommerce, cloud, streaming to name a few. We believe that there are key technological trends that will reshape the global landscape as consumer behaviour changes for good. What we question is the premium which investors are willing to pay for such stocks. And whether the premium is based on extrapolating a continuation of these companies’ outsized profits, market share and monopolistic influence into the distant future.

We are also not suggesting that every stock within the cheapest quintile of the index will eventually shine. There are companies which are cheap for a reason. Through fundamental analysis, we filter out poorly-run companies, broken business models as well as value traps and seek to identify good companies that are trading below their fair valuations. Ultimately, we invest in companies where we are highly confident that their discounted valuations are a result of temporary near-term headwinds and that these companies would deliver sustainable earnings over the long term. At the point of writing, we have found attractive opportunities in South Africa and Mexico where investors may tend to overlook given the unfavourable news headlines. We also have broad exposure across China, just not in the overpriced sectors. Our investment philosophy takes advantage of investors’ behavioural bias – the tendency for investors to over-react to both good and bad news, causing them to overpay in the former and underpay in the latter. The pandemic has compounded these tendencies.

We believe that buying value stocks at this point in the cycle at such extreme valuation dispersion, increases the probability of us adding significant value (excuse the pun) to our portfolios over the medium and long term.

Why value now?

Value has underperformed growth in the last ten years, testing the resolve of even the most committed value investor. So why look at value now? For one, we believe that today’s record valuation dispersion highlights the significant opportunities available as well as the risk to existing growth-biased emerging market exposures.

At the same time, value’s decade-long underperformance has taken place against a backdrop of eroding inflation expectations and falling interest rates. Low discount rates have in turn justified the lofty valuations of many growth stocks. Today, the unprecedented fiscal and monetary stimuli aimed at offsetting the impact of COVID-19 has caused money supply to spike. Fig. 3 shows that M2, a measure of money supply which includes cash in circulation as well as in savings deposits, has hit a record high as a percentage of nominal GDP.

Fig. 3. Record high level of M2 to GDP

wh-i-chart-03

In more normal times, such high levels of excess cash would fund the purchases of financial assets (which we have seen) as well as goods and services. In the months ahead, optimism over a successful vaccine or treatment can cause a rise in inflationary expectations. Less uncertainty over the macro outlook and higher discount rates can compel investors to seek out the bargains found in value stocks.

Time to diversify

Our research tells us that most asset owners are likely to have a growth bias in their existing emerging market exposures since value managers currently account for only about 10% of the Global Emerging Market universe1. This implies that value managers are likely to offer substantial diversification benefits for long term investors with existing emerging market exposures.

Even for investors without existing growth-biased emerging market exposures, it is reasonable to assume that the extreme valuation divergence is throwing up attractive opportunities. Ironically the extended period in which value investing has not worked, sets the stage for value investing to return.

History tells us that the rotation to value tends to be hard and fast. Investors may want to get prepared.

Disclaimer Strictly Private and Confidential. For Institutional, Wholesale or Professional Investors Only. Not for distribution to the retail public. This document is produced by Eastspring Investments (Singapore) Limited and issued in: Singapore and United States by Eastspring Investments (Singapore) Limited (UEN: 199407631H).


This document is solely to be used for informational purposes only and is not intended for anyone other than the recipient. This information is not an offer or solicitation to deal in shares of any securities or financial instruments and it is not intended for distribution or use by anyone or entity located in any jurisdiction where such distribution would be unlawful or prohibited. This document may not be copied, published, circulated, reproduced or distributed without the prior written consent of Eastspring Investments.


Information herein is believed to be reliable at time of publication but Eastspring Investments does not warrant its completeness or accuracy and is not responsible for error of facts or opinion nor shall be liable for damages arising out of any person’s reliance upon this information. Any opinion or estimate contained in this document may subject to change without notice.


Past performance and the predictions, projections, or forecasts on the economy, securities markets or the economic trends of the markets are not necessarily indicative of the future or likely performance of Eastspring Investments or any of the strategies managed by Eastspring Investments. An investment is subject to investment risks, including the possible loss of the principal amount invested. Where an investment is denominated in another currency, exchange rates may have an adverse effect on the value price or income of that investment. Furthermore, exposure to a single country market, specific portfolio composition or management techniques may potentially increase volatility. The information contained herein does not have any regard to the specific investment objective(s), financial situation or the particular needs of any person.


Where included, benchmark and index data included in this document are provided for illustrative purposes only. The portfolio and/ or services mentioned do not formally track any such benchmarks or indices and no representation is made as to relative future performance or tracking deviation. You should note that investing in financial instruments carries with it the possibility of losses and that a focus on above-market returns exposes the portfolio to above-average risk.


Performance aspirations are not guaranteed and are subject to market conditions. Higher yielding investments can produce income at the expense of capital growth or the capital value of the investment. High volatility investments may be subject to sudden and large falls in value, and there could be a large loss on realization which could be equal to the amount invested.


Eastspring Investments (excluding JV companies) are ultimately wholly-owned / indirect subsidiaries of Prudential plc of the United Kingdom. Eastspring Investments and Prudential plc are not affiliated in any manner with Prudential Financial, Inc., a company whose principal place of business is in the United States of America. Eastspring Investments Inc. (Eastspring US) primary activity is to provide certain marketing, sales servicing, and client support in the US on behalf of Eastspring Investment (Singapore) Limited (“Eastspring Singapore”). Eastspring Singapore is an affiliated investment management entity that is domiciled and registered under, among other regulatory bodies, the Monetary Authority of Singapore (MAS). Eastspring Singapore is also registered with the US Securities and Exchange Commission as a registered investment adviser. Eastspring US seeks to identify and introduce to Eastspring Singapore potential institutional client prospects. Such prospects, once introduced, would contract directly with Eastspring Singapore for any investment management or advisory services. In marketing Eastspring Singapore’s services, the Adviser’s employees also may make recommendations about securities that constitute investment advice. Eastspring US does not contract directly with any prospective client, nor does it have any discretion over client assets, nor does it trade, deal or direct trading in any security, client account or fund. Eastspring US does not receive or retain any assets or securities, nor does it serve as a custodian or direct any custodial decisions. Additional information about Eastspring Investments is also is available on the SEC’s website at www.adviserinfo.sec.gov