Emerging-markets roundtable: Part 1

 Chuk Wong, vice-president and portfolio manager at Goodman & Co. Investment Counsel Ltd., which manages the Dynamic stable of mutual funds. His mandates include lead portfolio manager for Dynamic Global Value, Dynamic EAFE Value Class, Dynamic European Value and Dynamic Far East Value.

 Chris Arbuthnot, senior managing director and senior portfolio manager at Manulife Asset Management Ltd. Based in Boston, Arbuthnot's responsibilities include Manulife Global Opportunities and a new mandate this year, Manulife Emerging Markets Equity, which was launched in May.

Moderating their discussion was Morningstar columnist Sonita Horvitch, whose three-part series continues on Wednesday and concludes on Friday.

Q: What is the impact of the European and U.S. sovereign-debt problems on the emerging-market economies?

Perez-Coutts: Economic growth globally will moderate. There will be a different impact on each emerging-market economy. Countries like China, which have significant exports to Europe and the United States, are being affected. But the negative impact on emerging-economy growth is far less than that caused by the downturn in 2008.

Chuk Wong

The slowdown in emerging-markets growth this year is also due to the deterioration in the inflation picture in some countries. Monetary authorities had to act and have increased interest rates. Finally, on their financing, some emerging economies do depend more on external funding, such as from the inter-bank market, than others. An example is South Korea.

Wong: India is also dependent on global funding.

Perez-Coutts: Right. After 2008, the countries tried to change this. Korean banks, Taiwanese banks do have a little more dependency than is the case in some other emerging economies.

Overall, the negative banking situation in Europe, and to a certain extent the United States, will impact some emerging economies. The good news is that their governments can come to the rescue. The bottom line is there is an adverse impact from the sovereign-debt crisis in Europe and the slowdown in the United States, but a lot of these consequences can be managed by emerging economies.

Arbuthnot: If we rewind to the beginning of this year, before the problems in Europe resurfaced, emerging economies were a little too hot. They were growing at a fast pace. Inflation was becoming a problem. Central bankers in some countries like Brazil and India were raising rates pretty aggressively.

Then you had this global macro shock. Emerging-market economic growth has weakened a little. The problem is that the inflation issues in these countries have not gone away. There is reluctance to use the traditional monetary policy tool of lower interest rates to promote growth, as inflation remains stubbornly high.

	Chris Arbuthnot

But, in perspective, the growth in emerging economies will still be the envy of developed economies. Over the next 12 months, inflation is likely to come down in a lot of emerging economies, because of lower commodity prices.

Perez-Coutts: There is only so much room for inflation to come down because of this. In most emerging economies, there is already so much that has been done over the last 10 years to lower inflation, using monetary-policy tools. Now, there is a need for structural changes. These economies will need to improve productivity, based on infrastructure spending. Otherwise, the rate of inflation will remain relatively high.

You are now seeing countries like Brazil, concentrating on macro infrastructure policies. India is trying to address this. China is trying to continue with some level of infrastructure build-out. Another reason why inflation in developing economies came to the fore this year was that the stimulus packages that were introduced in 2008 overstayed their welcome.

Wong: Emerging economies have recovered more rapidly than developed countries from the 2007-2008 lows. In the emerging economies, the high growth has brought them to full capacity.

Q: Can the emerging economies be the engine of global growth?

Perez-Coutts: They cannot carry the global economy yet. They are growing so much faster than developed countries that they will be able to shortly.

Wong: In the past 20 or 30 years, most emerging economies have adopted an export-driven growth model. The test is: To what extent they can transform themselves to a more balanced type of economy?

Perez-Coutts: Brazil is a remarkable case in point. Not long ago, it was far more dependent on exports of raw materials. Now, 30% to 40% of its economic growth is sourced domestically.

Q: Why have emerging-market stocks performed so badly this year, even though their economies, for the most part, are robust?

Patricia Perez-Coutts

Wong: They have fallen victims to the risk-on-risk-off trade. Unfortunately, emerging markets as an asset class are perceived as being more risky. When you have a risk-off trade it hits these stocks. Yet some emerging economies are in better shape than some developed economies, and should therefore be considered less risky. Are Greece and Portugal low-risk countries?

Arbuthnot: The bond market is telling you that they are more risky.

Wong: The stock markets in emerging economies are too dependent on foreign investors. Some emerging-market companies prefer not to have too many foreign shareholders. These investors tend to be more short-term. They come in and over-reward the stock price and when they exit they over-penalize it. The long-term case for emerging markets remains intact.

Perez-Coutts: If you look at all the headlines about these economies, it is clearly difficult for many investors to evaluate what is happening. From a bottom-up perspective, life goes on in many of these companies. When investors head for the exits, there is no regard for the fundamentals of the companies. There are some misplaced perceptions and this provides entry opportunities. Valuations are reasonable.

Arbuthnot: You find that in countries like Brazil, a lot of the big, benchmark names tend to be commodity-related companies and tend to be more volatile. The big names in Brazil include steelmaker Gerdau S.A., Petrobras, and metals and mining company Vale S.A.

The average stock in Brazil is not going to be as sensitive to what is happening globally. It is harder for investors to do bottom-up analysis and find mid-cap names. They gravitate to the ETFs. Also, 2008 scared a lot of people. These emerging markets went down significantly. It is very fresh in investors' minds.

Wong: Yes.

Perez-Coutts: The emerging-market stocks re-surged in 2009, there was positive economic growth and the sentiment was positive. But this sentiment changed in 2011 with the European crisis. There are some issues in emerging markets that are negative. For example, China did stimulate in a timely fashion, but the stimulus stayed too long. The authorities have tightened and removed some of the liquidity. It is a tricky balance.

Q: The MSCI Emerging Markets Index's performance this year?

Perez-Coutts: The MSCI Emerging Markets Index has underperformed the MSCI World Index in the first 11 months of this year by 10%. I don't focus on this, but on portfolio management.

	Index (total return in C$)	1 Yr.	3 Yr.	5 Yr.	10 Yr.
	MSCI Emerging Markets	-12.2	16.0	1.5	10.3
	MSCI World	1.0	5.7	-3.7	-0.2
	For periods ended Nov. 30

Arbuthnot: Likewise.

Wong: The mid-cap and small-cap emerging-markets stocks got punished more than big caps because they are considered even more risky.

Perez-Coutts: There is less liquidity in these smaller caps.

Arbuthnot: There is high insider ownership in emerging-market stocks, which limits the float.

Perez-Coutts: It is certainly a case of know your market.

Photos: www.paullawrencephotography.com