Investors Pull $50B From Emerging Markets, Outpacing '08 Crisis

The level of pessimism about emerging markets is unprecedented, leaving 2015 poised to be the third straight year of outflows, says Allan Conway of Schroders, a 35-year sector veteran.
By Simon Constable ,

NEW YORK (TheStreet) -- Bearishness about emerging market economies in general, and China in particular, has reached an unprecedented level, according to a fund manager who has specialized in the sector for more than three decades.

"More than $50 billion has been withdrawn from emerging markets in the first nine months of this year, which is more than in the 2008 financial crisis," says Allan Conway, head of emerging market equities at Schroders, and portfolio manager of the $1.3 billion Schroder Emerging Market Equity Fund (SEMNX) - Get Report

He cites data from Morgan Stanley research that shows a total of $57.6 billion fleeing fast-growth countries like China in the first three quarters of 2015, following two years of outflows in 2013 and 2014. 

"A third successive year of withdrawal will be first time ever that has happened," he says.

If you buy into investment flows as a contrarian indicator, then withdrawals of this magnitude from the sector should be bullish.

That said, money fleeing the sector has clearly weighed on returns, with the Schroder emerging-market fund seeing a year-to-date decline through the week ending Nov. 13. During that period, the fund dropped 11% compared with a fall of 15% for the iShares MSCI Emerging Markets (EEM) - Get Report  exchange-traded fund, which tracks emerging market stocks.

The Schroder fund has annual expenses of 1.24%, which Morningstar considers average for the sector, versus 0.68% for the exchange-traded fund.

Conway's optimism stands in stark contrast to the overall pessimism of the sector, and he explained his perspective further in a question-and-answer interview with TheStreet:


Q. How do you choose your investments?

A. We get half of of our alpha [or returns in excess of the gains from the broad market] from picking the country and then half from picking stocks.

We start off by choosing which countries are the most attractive, using our proprietary model. Typically, we overweight the six most attractive and underweight the six least attractive. We've used the model for many years, and it includes many factors, but we haven't discovered the holy grail.

Q. Would you give us some idea of what's in the model?

A. We include price-earnings growth, currency momentum, interest rates, etc. None of them are particularly surprising, but the strength of the model is that it provides a structure and discipline to look across an entire range of countries and isn't biased by the most recent news.

For instance, despite the competitive devaluation [in China's currency, the yuan], we have been overweight in China all year.

Q. It's clear from your top 25 holdings that you like China. Why is that?

A. There is far too much bearishness of China. We think that it is largely overdone. It's interesting to note that even with the slowdown, it is still one of the fasting-growing countries in the world.

The developed world [like the United States and Western Europe] isn't growing very fast for the foreseeable future, and this will continue to be the case. Meanwhile, you have a groundswell in India and China, where people are getting wealthier and spending.

China now exports more to other emerging markets than it does to the G7 [the so-called Group of 7 major economies, which includes the United States.] Although the growth is slower, it is still superior growth.

Since 2012, the services sector has been contributing more to the Chinese economy than manufacturing. Services are on a rising trend. 

Q. What is your least favorite emerging-market country?

A. Turkey is a least favorite country. Firstly, it has high fiscal deficit and it needs foreign capital. Whenever you are in a global environment of rising rates, that can make things hard [because capital will tend to flow to developed markets like the United States in search of higher yields and lower risk]. For the time being, that's a problem.

What compounds the problem is politics. Although there is relief that the AKP [The Justice and Development Party] 
has an overall majority, the reality is the AKP policies are not positive for the economy, and the macro backdrop isn't good.

Oil at $20 would be good for Turkey, but it is pretty unlikely to happen.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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