Emerging-market equities are back in vogue. Whether it is primary-market activity, secondary-market trading volumes or performance levels, the asset class is on a roll and analysts reckon there is much more to come.
To gauge how much interest is building in emerging-market equities, consider two deals that were priced last month. On September 12, Deutsche Telekom sold its 10.1% stake in Russia's Mobile TeleSystems, raising $1.5 billion within a matter of hours. A sale of local shares, it is the biggest Russian equities deal so far this year.
That same week a consortium, led by Turkish conglomerate Koc Holdings, made a successful $4.14 billion bid for a 51% stake in local oil refiner Tupras. The amount offered was well above market expectations and prompted the Istanbul Stock Exchange to rally by 1,000 points immediately after the deal.
Liquidity levels are surging. Flows into emerging-market equity funds this year are just under $9 billion, nearly three times total inflows in 2004, according to research outfit EmergingPortfolio.com Fund Research (EPFR). The emerging-market equity markets have rallied before, most notably in 2003, but this advance is shaping up to be different.
Two issues stand out. First, the macroeconomic environment in most emerging markets is healthy. Second, many companies have made tremendous strides in improving their corporate governance over the past few years. Their shares are now proving attractive to investors searching for yield.
For the first time, significant crossover and hedge fund money is finding its way into the asset class. Moreover, with the outlook for the US dollar weak over the medium term, the chances are that more of these investors will buy emerging-market equities in a bid to diversify their portfolios and add alpha.
This demand is fuelling primary-market activity. Already issuance volumes this year have surpassed last year's total. Up to mid-September there had been $20.9 billion-worth of international transactions by emerging-market companies, according to Dealogic, compared with $15.3 billion in 2004. Much of this activity is coming from Asia, with Chinese entities in particular executing big-ticket deals.
Local market activity is also looking healthy. In Brazil, for example, 11 companies had tapped the São Paulo exchange by the beginning of September, of which five issues were IPOs. This is building on last year's 16 equity deals. The head of Abrasca, Brazil's association of publicly traded companies, says that the country has not seen this level of issuance since before the 1997 Asian financial crisis.
The secondary markets also have greater depth. Total daily trading in emerging markets is about $20 billion, more than twice the average level of recent years, according to Deutsche Bank. Over 30 stocks trade more than a $100 million a day, the bank adds. All this should help attract more global funds.
So should the asset class's potential return, which is poised to outperform emerging-market debt this year. While bonds are up 8.5% year-to-date, according to JPMorgan's Embi+, emerging market equities are up 11.8% in dollar terms and 13.7% in local-currency terms, according to the MSCI index.
Yet what makes the asset class really exciting is its potential. Despite the jump in net inflows this year, investors are 0.5% underweight the asset class, according to Deutsche Bank. In many ways, emerging-market equities are still playing catch-up with their debt counterparts.
New money flows into emerging-market equities have accounted for 5% of assets under management since the start of the year but 16% in debt, according to EPFR. But with valuations generally attractive – emerging-market equities are cheaper than their developed-market peers and emerging-market debt – the outlook is definitely bullish.