Investors who have focused this year on short-term issues affecting only a few emerging markets may be missing a larger picture. We believe emerging markets – while volatile at times – will continue to offer potential opportunities in the foreseeable future, as the economic backdrop from the start of 2018 is still present today.
- We expect steady global growth for the remainder of 2018, which we believe will provide opportunities for exporting countries across the emerging markets.
- We believe emerging market equity valuations remain attractive versus developed markets.
- Structurally, emerging markets are evolving quickly. They now are driven more by secular factors, such as improvements in technology, versus the commodity-led boom-and-bust cycles that characterized emerging market returns as recently as 10 years ago.
- As long as the world can avoid the threat of trade wars, we believe emerging markets across Asia will have solid economic growth rates and benefit from a demographic tailwind of their large Millennial populations.
Impact on Fund performance
The Fund’s recent performance reflected macro events during the second quarter and mainly reflected the negative impact of:
- An overweight position to Russia compared to the MSCI Emerging Markets Index, the Fund’s benchmark index – The Russian market fell around 12% over the quarter because of the impact of economic sanctions imposed beginning in April. Russia was one of the best-performing emerging markets in the first quarter, but the sanctions caused a steep sell-off and currency depreciation. While recent news of a potential easing of the sanctions prompted a slight rebound of the Russian market, the ruble continues to be a drag for U.S. dollar investors. We have reduced exposure to Russia and cut the Fund overweight position in half. We still have a positive view toward Russia, given oil prices, and we think we have invested in attractive businesses for the Fund there at attractive valuations.
- An overweight position to Brazil compared to the benchmark index – The market and economy in Brazil were hurt by turmoil from a trucking strike in protest over higher fuel prices. The market was down more than 27% in U.S. dollar terms during the quarter. The strike’s impact prevented the delivery of foods to supermarkets and gas to fueling stations, putting severe pressure on the economy. We had steadily reduced exposure to Brazil during the last six months and now have moved to an underweight position.
- Fears of a widening trade war with China – A combined 60% of the Fund’s benchmark index is from China, South Korea and Taiwan. While these are strong and growing economies, concerns about the imposition of tariffs by the U.S. on China and other trading partners have hurt emerging markets. More than one-third of the Fund’s assets are allocated to China and we believe the U.S. and China will resolve the trade issues. While we do not think the issue poses a long-term threat to emerging markets or the Fund, we recognize the headline risk from the very public negotiating process.
Our outlook on emerging markets
We are monitoring a number of issues, including the trade tensions between the U.S. and its major trading partners, the yield on U.S. Treasuries and the impact on the U.S. dollar’s value versus emerging market currencies, the price of oil for its impact on both producing and consuming countries, and the outcome of elections scheduled in 2018 in Turkey, Mexico and Brazil, which all have uncertain outcomes and the potential for market disruption.
We expect steady global growth for the remainder of 2018, which we believe will provide opportunities for exporting countries across the emerging markets. We also believe emerging market equity valuations remain attractive. The estimated price/earnings (P/E) ratio for companies across emerging markets puts stock prices at about 12 times their projected earnings per share (EPS), compared with developed market equity prices at about 18 times projected EPS.
Many emerging market economies are becoming less dependent on commodities – and thus less cyclical – and more driven by secular themes based on “new economy” consumption levels, particularly in technology and financial sectors. For comparison, the emerging markets index 10 years ago was about 33% in energy and commodities. Those areas comprise about 14% of the index now. Technology was about 11% of the index 10 years ago, but now represents more than 30%. We would argue that there are only two places to get exposure to leading internet and technology companies: Silicon Valley and Emerging Asia, where there are dominant companies like Alibaba, Tencent and Samsung.
Despite the public rhetoric surrounding trade, we believe world leaders eventually will not embark on mutually destructive paths. Case in point: The U.S.-North Korea negotiations, in which the world has moved from the mutual threats of nuclear war only a few months ago to the historic meeting between President Donald Trump and Kim Jong-un. As long as the world can avoid the threat of trade wars, we believe emerging markets across Asia will have solid economic growth rates and benefit from a demographic tailwind of their larger Millennial generation populations. It has been estimated that more than 50% of the world's Millennials are in Asia, and that growing consumer culture offers potential for companies providing goods and services that they want now.
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.
Top 10 Equity Holdings as a percent of net assets as of 05/31/2018: Samsung Electronics Co. Ltd., 6.28%; Alibaba Group Holding Ltd. ADR, 5.68%; Tencent Holdings Ltd., 4.50%; Taiwan Semiconductor Manufacturing Co. Ltd., 4.12%; POSCO, 2.47%; Sunny Optical Technology (Group) Co. Ltd., 2.46%; Vale S.A., 2.29%; Ping An Insurance (Group) Co. of China Ltd., H Shares, 2.23%; Galaxy Entertainment Group, 2.08%; Sberbank of Russia PJSC ADR, 1.98%.
The MSCI Emerging Markets Index is an unmanaged index comprised of securities that represent large and mid-cap companies within emerging market countries. It is not possible to invest directly in an index.
Risk factors: The value of the Fund's shares will change, and you could lose money on your investment. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. These and other risks are more fully described in the Fund's prospectus. Not all funds or fund classes may be offered at all broker/ dealers.