Europe, Latin America have overshadowed Asia

Returns for first two regions are better over past decade, but economic outlook for third is more promising. Look before you leap

Despite all the hoopla over Asia, emerging markets in Europe and Latin America have fared much better in the past decade, warranting a closer look by advisors with clients seeking to invest overseas.

Based on the one-, three-, five- and 10-year performance of the Morgan Stanley Capital International gross standard annualized historical returns index for the periods ended Dec. 10, 2004, emerging markets in Europe outperformed emerging markets in Asia — and Latin America outperformed both (see table).

While individual markets in each of the three regions were in positive territory in the one- and three-year periods, all Asian markets — with the exception of India, Korea and Pakistan — posted negative 10-year returns.
On the other hand, all European emerging markets with a 10-year history and all Latin American markets were in positive territory for the 10-year period.

In Asia, Indonesia is the best short-term performer, up 57.4% in the one-year period. India, with a meagre gain of 4% over 10 years, is the best long-term performer. The worst-performing market in the Asian region for one year is Taiwan, up 4.9%, while the Philippines is down 12.6% over 10 years.

The best-performing market over the year in emerging Europe is the Czech Republic, up 88%, and the worst is Russia, down 2.5%. Over the 10-year period, Turkey, with a gain of 11.4%, is the best; Poland, up 7.5%, is the worst.

In Latin America, Colombia, with a staggering gain of 145.3%, is the best one-year performer; Peru, up 8.4%, is the worst. For the 10 years, Colombia, with a gain of 10.1% is the best; Argentina, up 1.2%, is the worst.

Compared to the overall MSCI emerging markets index, Asia has underperformed the benchmark in each of the four tracked periods, while both emerging Europe and Latin America have outperformed it.

In reality, markets in each of the three regions go in and out of favour with investors over time and it would be imprudent to make an investment decision based on pure performance. End-date sensitivity should be taken into consideration, as it adds bias to long-term returns.

In assessing the performance of the three regions, Chuck Bastyr, managing director and portfolio manager at BPI Global Asset Management in Florida, cautions that “one has to also look at trough valuations” — that is, the low end of the market instead of “end-of-period performance.” He says that current Latin American 10-year returns are based on a relatively low base following the late 1994 Mexican peso crisis, which had a domino effect on other Latin markets.
“Coming out of this trough, therefore, makes the 10-year returns look good,” he says.

Asian markets, on the other hand, fell in 1997 during the currency crisis in the region and are still recovering. “One has to look at where Asia is going and not where it is today,” Bastyr says. “It has 60% of the world’s population and is the biggest global growth engine,” which puts Asia in a strong position to provide superior returns to Latin America. “If you go from trough to trough, you could see Asia coming out way ahead of Latin America by 2008,” he adds.

On the other hand, emerging Europe has not yet had a major crisis but its performance is being driven by several factors, says Bastyr: “Primarily the dramatic political change in the region from communism to capitalism, and convergence among the regional economies. A lot of capital is being freed up; labour costs are low, creating outsourcing opportunities from industrialized European countries; taxes are low; assets are being reflated, resulting in higher property values; and bank stocks are rising.”

BRIDGING THE DIVIDED

Indeed, convergence has facilitated greater political and economic benefits to emerging Europe as a whole, as well as to individual member countries. For the first time since the end of the Second World War, the East/West divide has been bridged, enhancing regional security and political and economic stability. New markets have opened up, promoting trade and investment and offering businesses a choice of locations, improved economies of scale, reduced costs and increased competitiveness. In addition, emerging Europe has taken a hard look at improvements in budget deficits, debt inflation, trade, exchange rates and interest rates in keeping with convergence trends.

Mark Grammer, vice president of investment at Mackenzie Financial Corp. in Toronto, argues that the risk premium in Asia is higher, stemming from “nervousness that the Asian crisis could rear its ugly head again.” He believes investors have a greater level of comfort investing in emerging Europe, which has a lower risk premium.
Moreover, the underperformance of two of Asia’s larger markets, Taiwan and Korea, has been a drag on their region’s performance. “This is merely a time-sensitive phenomenon that skews Asian returns lower,” he says.

Grammer claims Latin America has been buoyed by its proximity to the U.S. and the North American Free Trade Association.
“Mexico’s solid performance and its heavy weighting on the index have also pulled up the rest of Latin America,” he says. Asia is certainly a better bet than Latin America, whose “history of turmoil” must also be considered.

Historically, Latin America has been plagued by financial and political turmoil, including the Mexican peso crisis, the Brazilian real crisis, failure of the Argentine financial system and a smorgasbord of political problems.

Eastern Europe, by contrast, is cashing in on high levels of corporate and individual investing. “There is great incentive to shift production to emerging Europe because of lower labour costs and proximity to transportation,” says Grammer. “It might be more worthwhile to build a new manufacturing plant in the Czech Republic than in Germany.” Many emerging European companies also have Western strategic partners and management expertise, he notes.

Stronger currencies are also a big factor in the performance of eastern Europe, says Grammer. Conversely, this has affected the performance of the Asian markets, which are more closely tied to a sinking U.S. dollar.
“A year ago, the picture would have been different for Asia, when the US$ was stronger,” he says. “If the US$ strengthens, returns in Asia will be boosted by currency alone.”

Vincent Fernandez, vice president and senior portfolio manager of global and U.S. equities at Toronto-based RBC Global Asset Management Inc., also likes Europe. “Both emerging Europe and Latin America are benefiting from the current strength of the resources sector,” he says. “Russia and Brazil, for instance, have large resource sectors.”

Fernandez looks at the dynamics of the three regions from a macro perspective. “Asia is experiencing a corporate crisis, while emerging Europe and Latin America are experiencing national crises,” he says. “In Asia, this has led to a resetting of prices, but in emerging Europe and Latin America this is more a sovereign issue.

“[Fundamentally], it is not as difficult to handle a sovereign issue as it is to deal with
issues facing many companies,” he says.
“Sovereign risk has declined significantly with convergence in Europe, leading to forced valuations — compared with competitive valuations in Asia.”

All three regions are experiencing healthy economic growth, with Asia’s growth forecasted to be stronger than emerging Europe. Latin America is increasingly focusing on expanding regional trade initiatives and could present additional opportunities in the future.

Typically, stock market performance in all emerging markets is volatile and fraught with risk, albeit declining with maturity. Emerging Europe and Latin America may appear to be better investments than Asia, based on pure performance numbers, but the underlying risk/

reward factors in each region must be carefully considered prior to choosing one region over another.

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.

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