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Good behaviour: Value opportunities in global emerging markets

Global Emerging Markets are getting out of the doldrums but investors beware the influence of behavioural bias, says Andrew Cormie, portfolio manager at Eastspring Investments.

Global Emerging Markets are getting out of the doldrums but investors beware the influence of behavioural bias, says Andrew Cormie, portfolio manager at Eastspring Investments.

The previous five years of value investing in Global Emerging Markets (GEM) were pretty lack lustre, with 2015 a particularly difficult year for value stocks. This was a result of a weak global economic environment, falling commodity prices and political instability that combined with slowing economic and corporate growth in emerging markets.

Much of the underperformance of the value style was a result of investors significantly shortening their investment horizons in response to economic headwinds and focusing on certainty and quality at the expense of everything else; paying little or no attention to the price they were paying.

This trend reversed last year. Supported by signs of a revival in economic and corporate growth across GEM equity markets value investing roared back. The result was outperformance across virtually every major geography and companies of all sizes.

There are still plenty of great opportunities, especially in GEM equities where the size of the valuation gap between value and quality stocks remains large.

In determining current opportunities in this market, it is important to note the importance of behavioural biases that can drive the market. Human beings are hard-wired to respond emotionally to their environment–and investors are no exception. The emotion associated with loss tends be more powerful, and has a more lasting effect, than the emotion we experience after a gain.

These behavioural biases often create significant distortions in the prices of stocks away from a level justified by an objective view of sustainable earnings.

Investors will always find opportunities driven by participants’ behavioural biases, such as a tendency to over-react to new information or run with the herd mentality. Some stocks will become oversold relative to their long-term earnings potential; others will become crowded trades–highly correlated and expensive.

The best way to illustrate this is by example. In late 2015 and early 2016, as many stocks in Brazil had become significantly undervalued, we increased our exposure to several high conviction ideas. As Brazil has become very popular more recently, many of the stocks we owned have reached or exceeded our valuation targets, and we are now paring back some of these positions.

There is a significant value opportunity available in GEM equity markets today. In order to fully take advantage, however, investors will need to do their research, be selective and be aware of the opportunities that investors’ behavioural biases create.


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