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Growth investing loses appeal in emerging markets

Equity collapse and economic decline have put paid to the strategy.

Written by Reuters | London | Published: August 19, 2013 1:46:13 am

If the popping of the dot-com bubble in 2000 spelled the demise of growth-at-any price investment strategies in the West,2013 may be the year for this to happen in emerging markets.

Emerging market investors,just like their dot-com predecessors of the 1990s,are learning the hard way the risks of paying higher and higher prices for assets in the hope that turbo-charged future growth will deliver the payoff.

Now an emerging equity collapse,coming amid a steep growth decline,may have put paid to the so-called growth investing model that has for years blinded fans of the sector.

Counting from end-2010,emerging equity returns stand a thumping 50 per cent below US markets. And this year may be final straw — as a growth slowdown gathers pace in the developing world,share prices are lagging developed peers by over 20 per cent and US stocks by a third.

Time,many say,for a shift to value-based investing — buying shares which are deemed to be trading at a discount to their fundamental worth. In other words,eschewing some of those Indian or Russian retail stocks that trade at 50 times forward earnings on the premise of explosive future consumption growth.

“A good strategy at such a time could be to play more on the value side and avoid some of the stories in countries and stocks that still look expensive,” said Giordano Lombardo,CIO of Pioneer Investments in Milan.

Most emerging shares indeed seem very cheap. Average valuations are down more than 25 per cent from 2009,Deutsche Bank says,while US and European markets are mostly unchanged.

And a comparison with 2007 peaks makes their case even more compelling. The sector has de-rated by 50 per cent,Deutsche data shows. Developed valuations meanwhile are 28 percent off peaks.

On a book-value basis,almost every emerging market looks vastly cheaper than its history. Brazil,Poland and India for instance show a 30 per cent discount to their own 10-year history and South Korea is a quarter under its historical average.

The vaunted link between fast economic growth and stock market returns has been discredited by many a study — most notably by a 2005 report by London Business School academics Elroy Dimson,Paul Marsh and Mike Staunton.

Indeed,double-digit returns on emerging stocks before 2008 stemmed not from fast growth but from the market’s cheapness back in 2000 when the developing world was just recovering from crisis,Societe Generale analyst Albert Edwards says.

“Valuation is what matters for investing in emerging markets,not their superior growth story,” Edwards told clients.

It could prove hard to immediately apply the concept to emerging equities,however. In a relatively young sector,value investors could find that long-term historical data on valuations,debt or normalised earnings are elusive.

And many shares will be cheap for a reason — weak profit growth,poor corporate governance or excessive state meddling are all issues that dog companies in the developing world.

It can be tough therefore to find stocks that have both cheap valuations and strong fundamentals.

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