Emerging economies driver of global growth: Allianz Global

Investors are turning a bit skeptical on BRIC (Brazil Russia India China) because of the recent underperformance of their markets, says, Dilek Capanoglu, Chief Investment Officer (CIO) and Manager of the Global Emerging Markets (EMs) portfolio at Allianz Global.

Also read: India may outperform; like capital goods, banks: JP Morgan

"But if I look beyond the performance, if I look at the economies and the markets, the BRIC economies are still major economies in the world and they are driving global growth," says Capanoglu in an interview with Udayan Mukherjee of CNBC-TV18. And that is true of emerging markets in general, even as investors have suddenly developed a liking for markets like US and Japan. "If we would catch the global growth expectations, they have been coming down and even if you look at US gross domestic product (GDP) growth expectations, they are about 1.6 percent whereas in EMs, we still have over 5 percent GDP growth expectation for this year. So, global growth continues to be driven by the global EMS," says Capanoglu. Below is the edited transcript of Capanoglu’s interview to CNBC-TV18. Q: What is the current feedback that you are getting from your large investors, are people concerned that EMs have started underperforming developed markets over the last few months? A: If one looks at the EMs performance, the underperformance has been going on for much longer. We have close to two-three years of underperformance now. Year-to-date (YTD) EMs have continued their underperformance but this is largely because of a few factors such as investors looking at growth in the US markets and the money shifting into US. However, if one looks at where the YTD performance is coming from, it is unsurprisingly Japan, which has been a major outperformer after the currency devaluation. Q: Do you see this continuing, this kind of strength in US and Japan which is leading to this outperformance there? A: I am more cautious there. In Japan, for example, and in the short-term to medium-term, I think we are going to continue to see some inflows into the market especially in local currency and the performance there. However, if we would catch the global growth expectations, they have been coming down and even if one looks at US gross domestic product (GDP) growth expectations, they are about 1.6 percent whereas in EMs, we still have over 5 percent GDP growth expectation for this year. So, global growth continues to be driven by the global EMs. Q: Are you seeing redemptions in an EMs portfolio or is just that inflows have slowed down? A: Not at all. If you look at YTD inflows, that is close to USD 27 billion into EMs as an asset class. We have almost seen recent redemptions in April where we saw some money outflows but that was mainly from ETF money. In not only equities are we continuing to see good inflows within EMs. Asia and global EMs are seeing good inflows whereas Latin America and Europe, Middle East and Africa (EMEA) are seeing redemptions. One reason for that being, for EMEA for example, because of the proximity to the euro zone and that it is economically dependent also on the strength of the euro area. So, this is why it has been out of favour with investors despite cheap valuations. In Latin America, Brazilian market has been going through its phases and especially with the weakness in commodity prices and the question mark about the larger companies in Brazil, but the government intervention has dampened the sentiment there. Q: Would you say that there is skepticism about the whole Brazil, Russia, India, China (BRICs) idea right now over the last few months? A: If one is looking at the overall BRIC performance, I think people are questioning more and more in terms of the performance. However, if I look beyond the performance, if I look at the economies and the markets, the BRIC economies are still major economies in the world and they are driving global growth. This is why the BRICs market per se have underperformed because China is undergoing a structural shift in its own growth so away from the investment led growth to consumer led growth. Ofcourse this has some implications for EMs, the commodity prices has been under pressure because of the lack of demand from China as well. However, it just creates an uncertainty because people have been used to expect China to grow by about eight to ten percent. Now the Chinese government is even starting to talk about 7.5 percent and they would be happy with that. We can expect some volatility in the near-term. I think that the investors will have to change their perception of what to expect from Chinese growth. Q: What is your own order of preference in the BRICs universe given what your view on commodities is right now, how would you rank the BRICs in your own investment idea? A: Within the BRIC universe, we do like India. We also still like Brazil but selectively, we have added to some banks and also on the consumer side we like China’s consumer story. I feel consumer in general in emerging markets and in BRICs is still a long-term theme which we will be focusing on. Russia is very much a cyclical market, it is very cheap. But as long as we don't see a turnaround in the sentiment and an improvement or strengthening in the commodity prices, I think Russia will remain a laggard. Q: This preference for India, has it gained currency in the last couple of weeks with a fall in commodity prices? Is that why you are overweight? A: In India, since beginning of the year there was an increasing expectation of the government pushing through the reforms. So, this has helped the market performance as well and also in combination now with the fall in currencies. I was looking at the impact of a weakening oil price on the Indian current account deficit because the twin deficit is one area which we continue to watch. So, if the oil prices stay 10 percent lower, the impact on current account deficit (CAD) will be roughly a 0.6 percent improvement. I think the whole environment at the moment makes it much more likely that the government will achieve the targets which they have set for themselves.

I have also seen in the Indian press recently that says that the government is targeting to bring down the CAD to 2.5 percent which would be very good for the country. Q: What about growth? Our macro growth numbers have not been great, earnings growth has still not started picking up. Are you confident on that aspect? A: Growth globally is actually slowing down and within the global arena, India is still actually doing quite well. A 5.9 percent growth or 5 percent growth is still above what we are seeing in the rest of the world. I think we need to get used to the fact that the global economy has entered a slower growth pace for the foreseeable future. And I think that a five to six percent growth for India is very realistic. PAGEBREAK_ Q: So you are in the camp which believes that 2013 will be a slow year for global growth contrary to what has happened in the last few days because some of the numbers seem to indicate to a lot of people that growth is picking up again. A: It depends what you look at. One gets very mixed messages and also mixed data. There are some pockets of strength. However, if one looks at the industrial production data, for example, the global trade data, export data I think there is still some weakness there. Even if I look at the global Purchasing Managers' Index (PMI) and Asia, they are especially in an expansionary mode and not where people expect them to be. This is why I am thinking that this is something which will stay with us for sometime. Q: You think market is ahead of themselves? A: Market did get ahead of themself at the beginning of the year and then we had some consolidation in the market and some uncertainty. I think the expectation right now is that we will have a weaker first half and everybody is expecting the second half to be stronger and we will have to wait and see what happens in the global economy to see if this pans out. But I think there is still some risk on the downside. Q: So you think it could be a mirror image of the expectations, the markets performance, the first half could turn out to be stronger and disappointment lies in the second half? A: I think second half will be stronger compared on year-on-year basis. But it might not be as strong as people expect it. We have been seeing GDP expectations being brought down throughout the year last year. This year, we are seeing a trend of GDP growth expectations coming down. We are seeing earnings growth still being downgraded but nevertheless bottoming out. So, there are some signs actually of bottoming out which could lead to a stronger second half. Q: What did you take away from the Reserve Bank of India’s recent communication because bank stocks have done exceptionally well over the last three-four weeks and banks is your overweight in India? A: We like the private banks in India. The reason why we like the private banks is we like their asset quality. If I look at the recent results, they have delivered some good net income growth, their asset quality also remains well. They have grown through the retail sector, so the retail segment is picking up. Banks in India will benefit from is uptake in the investment cycle of corporates, but that hasn’t happened yet. Without increase in corporate spending, around 14-16 percent loan growth is achievable. The real boost would come if we can start seeing some confidence returning in the corporate. Also, on the SME lending side, there is some strengths, but that depends also on the consumer sentiment because the consumer sector has been quite weak recently especially if we look at the most recent car sales data or two wheeler data. The consumer sentiment will lead the shift in capacity utilization, which then will transform itself into capital spending. Q: Are you staying away for the moment from some of these exposures like autos? A: Yes, we don’t have any exposure in there. We do have some exposure through Tata Motors, but this is more a developed and a China story rather than India story. Q: But you do own FMCG companies, consumer companies? A: We do own consumer companies. The trend for those consumer companies is very good in long-term. These companies at the moment trade are at very high valuations, when we do our investments, when I assess companies, in a way, it makes me nervous to see how they have evolved. But if I look at three-five year horizon, structural growth and stable margins can be kept and hence we still favour those areas. Q: Given valuations, would you be tempted for example to tender in the Unilever offer or do you think you don’t want to ride that theme for two-three years? A: We haven’t made up our mind yet on that issue, but on a long term basis it does have value in it. Consumer staples not just in India but around the world do look very expensive at the moment. So we do take profits. It is not that we just let it run. We do take profits, but consumers should be a coup investment in any emerging market portfolio. _PAGEBREAK_ Q: You have largely stayed clear of the public sector banking entities in India? A: Yes. Q: Not a single exposure there? A: We have looked at State Bank of India, so that would be our only single exposure, but we prefer the private banks. This is also because of the loan book quality and their exposure to power projects, infrastructure projects and real estate etc. Q: Despite the valuation gap between the two? A: Yes. Q: Views on IT seem quite mixed between fund managers. Are you clear that IT is a big story to back in India or recent instances like Infosys make you cautious? A: We have been invested in the IT sector for long years. Infosys for example used to be one or our favourite companies which we used to own. Why did we like Infosys is because of their cost structure and  efficiency. They could get projects outside and they have main base of the employees based in India hence they had those superior margins and we did not mind paying for that. But, in the recent years, those margins have come under pressure, especially if you look at the IT sector and the projects. Given that the global economy is slowing down, companies are renegotiating their IT projects when they come up for renewal. So there is risk of a further margin squeeze and this is why I would not want to be overweight. Q: But you do have some exposure in some of the names there? A: Yes, we do have some exposure. Q: What you don’t like in India? Are there certain clusters of sectors that you have largely steer clear of? A: We don’t have exposure in the infrastructure area. We only have L&T, but this is also not just purely India, but also because of international backlog. We have stayed clear of real estate areas. Also, we haven’t had any exposure to the big generic pharma names, but we are looking at smallcap names there. Q: In commodities metals, cement or any of those, oil and gas? A: At the moment we don’t have any exposure there. Q: How do you think this whole emerging market or Asian market story will pan out this year given that there are so many fears about China and where eventual growth would be? Do you think large investors would still prefer the safety of something like US and not take that incremental risk to go to an Asian market? A: This is what we have been seeing in the past 12 months or so, but then we had USD 27 billion of inflows into emerging markets and most of it into global and also into Asia. So, Asia is certainly preferred by investors for its outlook. Markets which have also benefited are the smaller Asian markets. For example, Indonesia is still a favourite with investment world and Philippines has been getting a lot of attention. But both markets look very expensive compared to the rest of Asia to emerging markets and also compared to their own history. Q: Turkey as well? A: Turkey is one market, which is also well liked by investors, but on a valuation basis it does not look as expensive as compared to the Asian markets. The market structure in Turkey is deeper so you have more companies to pick from. What I like in Turkey is, if you look at the benchmark around 70 percent of the index, it is consumer related. By consumer related I don’t mean consumer staples. When I talk about the consumer it is also financials, consumer discretionary etc, so, Turkey is giving a nice exposure into that area. So, we do like Turkey within the global emerging market context. Q: You spoke about some recent exchange traded fund (ETF) out flows. What would you put it down to? A: ETF money, the passive money moving away from emerging markets - investors are becoming more selective. So, they are taking money out of ETFs and putting money into long only. But also some of the ETF money has gone down to Japan as we see in the most recent numbers. Q: You were speaking about Indian macro a while back. Do you derive more comfort about the Indian currency on the back of what has happened with commodities off-late because the currency has been a big problem for many global investors? A: Although if you look at the currency it has been sort of stabilising at the current levels and it has been sort of trading in a band. Improving current account deficit would definitely be supportive for the currency and also it would give the central bank some more room to ease policy rates as well. So, I am not really concerned about the rupee strength. If I look at the relative valuation of the rupee, it is about 10-15 percent undervalued at the moment looking at how it used to trade in the past. Q: In the next one year another issue which India has to contend with is the elections. Does it worry you; is it a big risk factor in your eyes? A: The current government is a minority government. So, there is certainly some risk factor even with the current consolation because the government relies on the regional parties and they can be at times quite unpredictable. So, this is a concern for us. Elections are still a year away, so let’s see what happens. There is always a talk of early elections because of the current constitution of the parliament, but we will get some more clarity as we come closer to that time. So, it is something we are watching, but it is not something I am overly concerned with at the moment. Q: Would it be fair to say that at least in the last few months the finance minister has been trying to do things which make you little bit more optimistic compared to what the situation was in India three years back or the last three years? A: Definitely they have come a long way. This is also why the market has performed so well because the focus was on fiscal consolidation and current account deficit. So, those reforms will continue. The focus will continue, the question mark is if we are in a pre-election mode how much of that are we likely to see – long term, it will happen, short term it might get delayed. Q: What is the biggest risk for emerging markets this year you feel? A: The biggest risk it is several fold. First of all inflation is always an issue while watching emerging markets. In some countries it is stickier than in others, India and Brazil being an example there although we are seeing some bottoming out trend there. The biggest risk I see for emerging markets is a shift in the global risk aversion again or the global growth expectations which might lead to capital outflows because capital flows have been very supportive of emerging market equities especially with the quantitative easing (QE) and I don’t expect this to end anytime soon. So, this is not my best case scenario but this still remains a risk and also with the euro zone if we have anymore noise there, Cyprus now is dealt with but we might get some other noise there as well. So, it is the global risk aversion and in China may be faster slowdown than people are expecting.