Home to more than 80 percent of the global population and accounting for more than 60 percent of global economic growth, emerging markets (EMs) offer a positive structural picture.
Following a number of uncertain years, dogged by elevated external vulnerabilities and economic headwinds, EMs now look sturdier. After a strong 2017 we expect 2018, with supporting macroeconomics, to be another promising year.
Most investors recognize the potential of EMs, yet struggle to find the right investment approach to participate in these appealing markets. EMs are highly diverse, spanning four continents and 20 time zones, and numerous currencies. The dispersion of historical returns is wide. Over the past 10 years, the difference in returns between the best and the worst of today's EM equity markets is approximately 300 percent.
What is the right approach?
We highlight four ways to invest in emerging markets, depending on an investor's objective and risk appetite, but highlight the importance of a sophisticated and well-structured investment process. Continuously monitoring the risks and return potential, and shifting the allocation to either improve the return profile or de-risk a given strategy is crucial.
1. The all-weather solution: Unlock potential across asset classes
The most promising approach to invest in EMs, in our view, is a dynamic multi-asset class investment, across debt and equity markets, that harvests the most interesting opportunities. Local debt markets offer very attractive levels of inflation-adjusted yields in what we believe to be undervalued currencies. Combined with external debt, typically issued in U.S. dollar, thereby providing a solid basis that can deliver attractive returns. Equity markets in turn capture growth potential and improving profitability as margins recover after a long earnings recession.
2. For the income oriented investor — corporate bonds
The EM corporate bond universe allows for broad diversification with over 50 countries and a total market size having surpassed the U.S. high yield market, which we see as a testament to the improving fundamentals and better ratings by many EM economies since the start of the millennium. The inflation-adjusted rates differential between EM and developed markets is close to the historical high reached in late 2017, hence offering an attractive investment opportunity. We remain constructive on EM local currency debt as potential EM risks are adequately priced in, in our eyes.
3. Benefit from EM winners in equities
Seizing the opportunity presented by the recent equity pullback in February, our investment committee has changed its view on EM equities to "outperform". Corporate profitability is improving as profit margins, which are still below their historical average, have come off the lows in 2016. The relative price-to-book ratio (a key metric used by traders to gauge the value of stock) is still trading at a 15 percent discount to its historical average and has room to improve further. The 2018 earnings vintage has seen positive momentum, the first in the last six years, and the breadth of revisions is even more impressive, as this ratio has turned positive for the first time since late 2010.
4. Undervalued EM currencies offer upside
We remain positive on EM currencies overall despite the increase in U.S. yields, as we expect growth to gather momentum on the back of persistent inflows and favorable financial conditions, including reduced external vulnerabilities. EM currencies are still benefiting from supportive fundamental valuations and attractive EM real rates. EM central banks might be biased to adopt a more hawkish stance as growth momentum improves in the coming quarters, benefiting carry in EM currencies.
All signs appear to be pointing to emerging markets; the macro backdrop is encouraging, the stabilization of commodity prices is clearly helpful and corporate investments are picking up, we see a good investment case across asset classes if managed well.
Michael Strobaek, global chief investment officer at Credit Suisse Group AG, with 1.4 trillion Swiss francs of assets under management, and chair of the Credit Suisse Investment Committee.
For more insight from CNBC contributors, follow @CNBCopinion on Twitter.
