Westaway citywire emerging markets.pptx final screen

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Westaway citywire emerging markets.pptx final screen

  1. 1. The role of emerging markets in diversified portfolios Peter Westaway Chief Economist and Head of Investment Strategy Group, Europe Vanguard Citywire Wealth Management Retreat The Grove, October 2013 This document is directed at investment professionals and should not be distributed to, or relied upon by retail investors. The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
  2. 2. Outline of presentation Market performance • EM equities traditionally outperform DMs over the long run, but they can underperform for long periods • Unwind of QE may harm EMs, but some fallback already priced in Economic performance • EM economies look set to continue to make a major contribution to world growth.....and within that, China will be very significant • Prospects for EM economies look promising but risks abound (domestic and global issues, ie Fed policy, sovereign crisis, China slowdown) Investment considerations for EMs • Correlation between EM equity returns and EM growth is weak • Contrary to popular belief, Ems are not a thin market where smart investors can make easy money Key point: EM equities have an important role in diversified equity portfolios 2
  3. 3. Investor interest in EM surged since the financial crisis Trailing 3-year flows in emerging equity products across the world Average annual flow over 36-month rolling periods (USD billions) 70 60 50 40 30 20 10 0 -10 -20 -30 1995 2000 2005 2010 Notes: Morningstar asset flows into US Open-end & EFT excluding Money Market funds, excluding Fund of Funds, Excluding Obsolete Funds and Diversified World Stock Source: Vanguard, based on data from the Morningstar. Data as of 13 September 2013. 3
  4. 4. EM equities have typically outperformed DM... but with more volatility Yearly percent change in total returns of developed and emerging market equities 100% 80% Year-on-year growth 60% 40% 20% 0% -20% -40% -60% -80% 1990 1992 1994 Developed Markets 1996 1998 2000 2002 2004 2006 2008 2010 2012 Emerging Markets Source: Vanguard Investment Strategy Group based on MSCI. Data presented is as of 17 September 2013. 4
  5. 5. EM equities have typically outperformed DM... but with more volatility Difference in yearly percent change in total returns of DM and EM equities 0.8 0.6 0.4 0.2 0 -0.2 -0.4 -0.6 -0.8 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Source: Vanguard Investment Strategy Group based on MSCI. Data presented is as of 17 September 2013. 5
  6. 6. EMs have outperformed DMs on average since 1990 but not systematically… recent performance has been lacklustre Emerging markets - developed markets relative return (Jan 1990=100) Emerging Markets-Developed Markets relative return (Jan 1990=100) 250 200 150 100 50 0 1990 1995 2000 2005 2010 Source: Vanguard Investment Strategy Group based on MSCI. Data presented is as of September 17, 2013. For additional details, see Vanguard white paper, Investing in emerging markets: Evaluating the allure of rapid economic growth, April 2010. 6
  7. 7. Emerging market valuations are now similar to those in developed market benchmarks 12-month trailing price to earnings ratio: Developed markets versus emerging 45 40 Emerging market valuations were not as elevated as developed markets in the early 2000's 35 30 25 Today, valuations are more similar 20 15 10 5 0 1995 1997 1999 MSCI Emerging Markets Index 2001 2003 2005 2007 2009 2011 MSCI World Index Source: Vanguard Investment Strategy Group based on MSCI. Data presented is as of September 17, 2013. For additional details, see Vanguard white paper, Investing in emerging markets: Evaluating the allure of rapid economic growth, April 2010. 7
  8. 8. Risky bond segments (e.g. EM) had returned to pre-crisis yields …but recent Fed-related worries caused yields to rise again 25 20 Yield 15 10 5 0 2007 2008 Global Inv-Grade Corporates 2009 2010 Global High Yield Corporates 2011 2012 2013 Emerging Market Debt Source: Barclays as of 30 September 2013. Notes: Global Investment Grade Corporates defined as the Barclays Global Aggregate Corporate Index, Global high Yield Corporates defined as the Barclays Global High Yield Corporate Index, and Emerging Debt Defined as the Barclays EM USD Aggregate. 8
  9. 9. EM economies are gradually taking a larger share of world GDP Share of world GDP, 1980-2012, and forecast through 2018 100% Share of Global Output of DM and EM economies 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1980 1985 Developed Markets 1990 1995 2000 2005 2010 2015 Emerging Markets Notes: Displays each region's share of global GDP, in nominal US dollar terms. Source: Vanguard, based on data from the IMF April 2013 World Economic Outlook Database 9
  10. 10. The global economy is still relying on emerging markets to drive growth Contribution to global real GDP growth, by market 5.0 4.5 Global Real GDP Growth 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1980s U.S. 1990s Developed Markets (ex U.S.) 2000s 2010-2013 Next 5 Years Emerging Markets Notes: Each region’s contribution to overall growth is defined as that region’s GDP weight at the beginning of each time period multiplied by that region’s annual average growth rate over the time period measured. Source: Vanguard calculations based on data from the IMF World Economic Outlook, April 2013. 10
  11. 11. ...and within that, China’s contribution should continue to dwarf that of other EM regions Contribution to Global Real GDP Growth, by market 1.8 1.6 Global Real GDP Growth 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 1980s China CEE 1990s ASEAN-5 2000s 2010-2013 Next 5 Years LATAM Source: Vanguard calculations based on data from the IMF World Economic Outlook, April 2013. Notes: Each region’s contribution to overall growth is defined as that region’s GDP weight at the beginning of each time period multiplied by that region’s annual average growth rate over the time period measured. ASEAN-5 countries comprise Indonesia, Philippines, Malaysia, Singapore and Thailand. 11
  12. 12. Regional developments: China – heading for a hard landing? Economic growth appears to have bottomed... Yuan appreciating modestly 0.16 14 10 USD/Yuan Real GDP Growth (Year/Year %) 12 8 6 4 0.14 2 0 2004 2006 2008 2010 0.12 2003 2012 Investment share of GDP, 2012 60% 2005 2007 2009 2011 China net exports, % of GDP Nearly 50% vs. the 15-25% that is typical of large economies 10.0% The recession forced some rebalancing to occur, more is needed 8.0% 40% 6.0% 20% 4.0% United Kingdom United States Italy Spain Brazil France Japan South Korea Russia Canada Mexico Germany Australia India China 0% 2.0% 0.0% 1995 1997 1999 2001 2003 2005 2007 2009 2011 Sources: IMF, National Bureau of Statistics of China, People’s Bank of China, U.S. Federal Reserve and Vanguard Investment Strategy Group. Data as of 19 September 2013. 12
  13. 13. Regional developments: ASEAN-5 economies – susceptible to an external slowdown Share of ASEAN-5 exports by destination 75% Share of global exports destined for developed markets 8 6 Real GDP growth 4 2 0 27% 70% 25% 65% 23% 60% 21% 55% 19% 50% -2 17% 45% -4 40% 2005 -6 2005 2007 2009 2011 2013 2015 2017 2007 Advanced 2009 2011 15% 2013 ASEAN-5 (RHS) Source: IMF, World Economic Outlook, April 2013 and IMF Direction of Trade Statistics and Vanguard calculations. Data as of 19 September 2013. ASEAN-5 countries comprise Indonesia, Philippines, Malaysia, Singapore and Thailand. 13 Share of global exports destined for ASEAN-5 Real GDP growth in ASEAN-5
  14. 14. Regional developments: India – structural challenges weigh on growth prospects Real GDP growth slowdown Investment slump has become a more generalised slowdown 12 Year-on-year growth Real GDP (year-on-year growth) 14 10 8 6 4 2 0 2005 2006 2007 2008 2009 2010 2011 2012 30 25 20 15 10 5 0 -5 -10 2006 2013 2007 2008 Private Consumption Real GDP growth and IMF forecasts 2010 Investment 2011 2012 2013Q2 Exports Real effective exchange rate 12 115 10 110 8 105 6 100 4 95 2 Real GDP (year-on-year growth) 2009 90 0 2006 2008 2010 Actual WEO, October 2012 WEO, September 2011 2012 2014 2016 2018 85 2006 2007 2008 2009 2010 2011 2012 2013 WEO, April 2013 WEO, April 2012 Source: IMF, World Economic Outlook, April 2013, Ministry of Statistics and Programme Implementation of India. Data as of 9 September 2013. 14
  15. 15. Regional developments: LATAM - capital inflows have likely been QE-fuelled Real GDP growth Capital flows by country (USDbn) 70 8% 60 Capital flows by country (billions of dollars) Real GDP growth (year-on-year per cent change) 10% 6% 4% 2% 0% -2% -4% -6% -8% 2004 2006 Brazil 2008 2010 Mexico 2012 2014 Others 2016 50 40 30 20 10 0 -10 -20 -30 2007Q1 2008Q1 2009Q1 2010Q1 2011Q1 2012Q1 Brazil Mexico Rest of LA5 LA5 total Notes: Other- Chile, Colombia and Peru Source: International Monetary Fund, World Economic Outlook April 2013. 15
  16. 16. Regional developments: Emerging Europe – Euro crisis has weighed on growth Gradual recovery from 2012 slowdown Exports to Euro area (Q2 2008=100) 105 10 100 Exports to Euro area (Q2 2008=100) 12 Real GDP growth (per cent) 8 6 4 2 0 -2 -4 -6 95 90 85 80 75 70 Around 50% of CEE exports are destined for the Euro area 65 -8 2004 2006 2008 2010 2012 2014 60 2008 2009 2010 2011 2012 CEE excluding Poland and Turkey Poland Turkey Source: International Monetary Fund, World Economic Outlook April 2013. Data as of 9 September 2013. 16
  17. 17. Investing in emerging markets: Be wary of the allure of economic growth • We find that the average cross-country correlation between long-run GDP growth and long-run stock returns has been effectively zero 17
  18. 18. Investing in emerging markets: Be wary of the allure of economic growth Real GDP growth and real stock returns 1970–2012 Average Annual Real Equity Market Return 14% 12% y = 0.05x + 0.05 R² = 0.00 10% 8% 6% 4% 2% 0% -2% 0% 2% 4% 6% 8% 10% 12% Average Annual Real GDP Growth Source: Vanguard, based on data from the IMF and FTSE. For details, see Vanguard paper, Investing in emerging markets: Evaluating the allure of rapid economic growth (Davis, et al., April 2010). 18
  19. 19. Investing in emerging markets: Be wary of the allure of economic growth • We find that the average cross-country correlation between long-run GDP growth and long-run stock returns has been effectively zero Three factors explain this seemingly counterintuitive result: – Economic growth surprises matter; expectations are priced in – GDP growth may not be a good proxy for earnings growth in a world of multinational companies – Much of the capitalization growth in emerging markets comes from share issuance rather than rising stock prices 19
  20. 20. Economic growth surprises matter; expectations are priced in US economic growth surprises vs. equity market returns, 1970-2012 US consensus economic growth expectations vs. equity market returns, 1970-2012 80% 80% R² = 0.2364 1-Year Stock Ahead Market Return 1-Year Stock Market Return 60% 40% 20% 0% -20% -40% -60% -10% -5% 0% 5% Economic Growth Surprises 10% R² = 0.032 60% 40% 20% 0% -20% -40% -60% -8% -3% 2% 7% Economic Growth Expectations Source: Vanguard, based on data from the IMF, FTSE and Philadephia Fed's Survey of Professional Forecasters. Notes: Economic growth expectations are defined as the 1-year ahead median forecast from the Philadephia Fed's Survey of Professional Forecasters. Growth Surprises are then defined as the actual change, relative to that expectation. Equity market returns are defined as spliced total market index For details, see Vanguard paper, Investing in emerging markets: Evaluating the allure of rapid economic growth (Davis, et al., April 2010). 20
  21. 21. GDP is a poor proxy for equity market earnings GDP growth versus earnings growth 1999-2012 14.0% 12.3% Average Annualized Growth 12.0% 10.0% 8.6% 8.0% 6.0% 5.2% 4.4% 4.0% 2.0% 0.0% Developed Markets GDP Growth Emerging Markets Earnings Growth Source: Vanguard, based on data from the IMF and FTSE. For details, see Vanguard paper, Investing in emerging markets: Evaluating the allure of rapid economic growth (Davis, et al., April 2010). 21
  22. 22. Share issuance is a large component of growth in market capitalisation Shares outstanding Components of market cap growth Jan 1995 - Dec 2012 375 14.0% 350 325 12.0% 300 10.0% Annualised Growth Jan.1995 = 100 275 250 225 200 175 150 8.0% 6.0% 4.0% 125 100 5.3% 4.8% 7.4% 2.0% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 75 EM DM 1.4% 0.0% Emerging Markets Share Growth Developed Markets Price Growth Source: Vanguard, based on data from the IMF and FTSE. For details, see Vanguard paper, Investing in emerging markets: Evaluating the allure of rapid economic growth (Davis, et al., April 2010). 22
  23. 23. Investing in emerging markets: Be wary of the argument that active management pays in EM Often argued that EM is a thin market where active bets are more likely to pay off. Theory and evidence suggest otherwise Theory: The zero-sum game which holds in any market: before costs, for every investment that outperforms the index of a chosen market, there has to be another one that underperforms. But once costs are taken into account, it means that low-cost index funds will have a greater probability of outperforming higher cost actively managed funds. Evidence: Our research suggests active managers no more likely to outperform in EM than in any other market. 23
  24. 24. The theory of the zero-sum game Distribution of pre-cost returns Benchmark return Below the market Above the market Source: Vanguard 24
  25. 25. Importance of costs to the zero-sum game Average return after costs Average return before costs Below the market Above the market Impact of costs Source: Vanguard 25
  26. 26. EM equity funds relative to MSCI EM Index 40 35 30 Dead funds: Active 52 Index 0 Alive funds: Active 130 Index 4 25 75% / 85% 25% / 15% 20 15 10 5 7 to 8% 6 to 7% 5 to 6% 4 to 5% 3 to 4% 2 to 3% 1 to 2% 0 to 1% Index More than 8% Active -1 to 0% -2 to -1% -3 to -2% -4 to -3% -5 to -4% -6 to -5% -7 to -6% -8 to -7% Less than -8% 0 Outperforming / outperforming adjusted for survivorship bias Source: Vanguard calculations, using data from Thompson Reuters Datastream and Morningstar, Inc. Performance is over 5-years ending 31 December 2012. Past performance is no guarantee of future results. 26
  27. 27. Active managers underperform on average Percentage of active equity managers underperforming their benchmark 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 5 Years 10 Years 15 Years EM Survivors Only Corrected for Suvivor Bias Source: Vanguard calculations, using data from Morningstar, Inc. Past performance is no guarantee of future results. 27
  28. 28. Debunking the market cycle myth Percentage of EM equity funds underperforming prospectus benchmark 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Bull Market: Jan-1998 to Aug-2000 Bear Market: Sept-2000 to Feb-2003 Bull Market: Mar-2003 to Oct-2007 Bear Market: Nov-2007 to Feb-2009 Bull Market: Mar-2009 to Dec-2012 Source: Vanguard calculations, using data from Morningstar, Inc. Past performance is no guarantee of future results. 28
  29. 29. Conclusions • EM equities outperform DM over the long run, but long periods of underperformance too • Unwind of QE may harm EMs, but some fallback already priced in • EM economies look set to continue to make a major contribution to world growth.....and within that, China will be very significant • Prospects for EM economies look promising but risks abound (domestic and global issues, ie Fed policy, sovereign crisis, China slowdown) • Don’t assume that EM equity returns will correlate with EM growth; avoid making portfolio decisions based on their expectations for a particular country or region’s economic prospects • It’s not any easier to make active bets in EM markets • EM assets have an important role in diversified portfolios 29
  30. 30. Important information The information contained in this presentation does not constitute an offer or solicitation and may not be treated as an offer or solicitation in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information in this presentation does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this presentation when making any investment decisions. The Manager of Vanguard Investment Series plc is Vanguard Group (Ireland) Limited. Vanguard Asset Management, Limited is a distributor of Vanguard Investment Series plc. Vanguard Investment Series plc has been authorised by the Central Bank of Ireland as a UCITS and has been registered for public distribution in certain EU countries. Prospective investors are referred to the Funds' prospectus for further information. Prospective investors are also urged to consult their own professional advisors on the implications of making an investment in, and holding or disposing shares of the Funds and the receipt of distributions with respect to such shares under the law of the countries in which they are liable to taxation. The Authorised Corporate Director for Vanguard Lifestrategy Funds ICVC is Vanguard Investments UK, Limited. Vanguard Asset Management, Limited is a distributor of Vanguard Lifestrategy Funds ICVC. The Manager of Vanguard Funds plc is Vanguard Group (Ireland) Limited. Vanguard Asset Management, Limited is a distributor for Vanguard Funds plc. All rights in FTSE Developed Asia Pacific ex Japan Index, FTSE Developed Europe Index, FTSE Japan Index and the FTSE All-World High Dividend Yield Index (the “Indices”) vest in FTSE International Limited (“FTSE”). “FTSE®” is a trademark of London Stock Exchange Group companies and is used by FTSE under licence. The Vanguard FTSE Developed Asia Pacific ex Japan UCITS ETF, Vanguard FTSE Japan UCITS ETF, Vanguard FTSE Developed Europe UCITS ETF and the Vanguard FTSE All-World High Dividend Yield UCITS ETF (the “Products”) have been developed solely by Vanguard. The Indices are calculated by FTSE or its agent. FTSE and its licensors are not connected to and do not sponsor, advise, recommend, endorse or promote the Products and do not accept any liability whatsoever to any person arising out of (a) the use of, reliance on or any error in the Indices or (b )investment in or operation of the Products. FTSE makes no claim, prediction, warranty or representation either as to the results to be obtained from the Products or the suitability of any of the Indices for the purpose to which it is being put by Vanguard. Issued by Vanguard Asset Management, Limited, which is authorised and regulated in the UK by the Financial Conduct Authority. © 2013 Vanguard Asset Management, Limited. All rights reserved. VAM-2013-10-01-1163 30

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