Has the Emerging-Market Safety Trade Gone Too Far?

The potential return for taking risk in emerging-market stocks hasn’t been this attractive in decades, as my colleague Henry D'Auria explains below.

Risk Looks Much Too Cheap

Since the eruption of the global financial crisis, investors have rushed en masse into the stocks of predictable, fundamentally stable companies and out of the stocks of more volatile, economically sensitive firms. In the emerging markets, where the flight to safety has been particularly intense, stability now looks much too expensive and risk looks much too cheap.

The magnitude of this gulf is illustrated by the display below, which plots the price-to-book value multiples of the lowest- and highest-beta quintiles of emerging-market stocks versus the multiple of the emerging-market index since the end of 1994. Beta is the degree to which a stock moves in tandem with the overall market.

High-Beta Stocks Are Unusually Cheap Vs. "Safe" Stocks In our analysis, the pricing gap between high and low beta stocks is wider than it's ever been. The lowest-beta quintile traded at a whopping 48% premium to the MSCI Emerging Markets Index at the end of March 2012—dwarfing the average 8% premium since 1995 and representing twice the premium seen during the Asian currency meltdown of 1997–1998. Meanwhile, the highest-beta quintile traded at a 24% discount, much steeper than the average 3% discount and comparable to levels reached in the 1997–1998 period.

As this research shows, emerging-market investors generally prize stability, and have typically awarded it a premium over time. In turn, they generally want more compensation for investing in higher-beta stocks—hence, the discount over time. While the high-beta discounts to the market and to its low-beta counterpart tend to expand during times of great market stress, they have been unusually severe and persistent in the current crisis. 

But, as this analysis also shows, such schisms are cyclical—and have typically presaged periods of strong outperformance for high-beta stocks. This was true following the Asian crisis, the bursting of the technology bubble and the 2008 market collapse. For example, the highest-beta quintile outperformed the market by 47% in the year after the valuation gap between high- and low-beta stocks peaked at around 57% in September 1998. In the year after the spread reached another high point in March 2009, high-beta stocks outperformed by 40%.   

Not surprisingly, the lowest-beta group tends to be dominated by consumer-staples, telecom and utility firms, and the highest-beta group by firms in resources, financials and other cyclical sectors. Given our value bent, it is also not surprising that our research has been increasingly uncovering attractive portfolio candidates among the stocks in the higher-beta sectors while cautioning against the “safe” stocks in the lower-beta sectors, which we believe have become excessively valued amid the investor fixation on near-term earnings certainty.  

We do not consider valuation in isolation, however. Our investment process carefully weighs near-term risks, as well. What makes the beta gap particularly provocative today is that there is little difference in the balance-sheet quality between the high- and low-beta quintiles. Such differences had largely justified  paying for safety following the late 1990s Asian crisis, when many high-beta companies had built huge debt burdens financed largely by foreign currencies just before their own currencies collapsed.

MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices, any securities or financial products. This report is not approved, reviewed or produced by MSCI.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Sharon E. Fay, CFA

Head and Chief Investment Officer—Equities
Sharon E. Fay was named Head and Chief Investment Officer of Equities in July 2010. She is responsible for overseeing AB’s portfolio management and research activities relating to all equity investment portfolios. Previously, Fay served as CIO of Global Value Equities from 2003 to 2014. From 1999 to 2006, she was CIO of European and UK Value Equities, serving as co-CIO from 2003 to 2006 after being named CIO of Global Value Equities in 2003. From 1997 to 1999, Fay was CIO of Canadian Value Equities. Prior to that, she had been a senior portfolio manager of International Value Equities since 1995. Fay joined the firm in 1990 as a research analyst, subsequently launching Canadian Value, the firm’s first single-market service focused outside the US. She then went on to launch the company’s UK and European Equity services and build Bernstein’s London office, home of its first portfolio management and research team based outside the US. Fay holds a BA from Brown University and an MBA from Harvard Business School. She is a CFA charterholder. Location: New York

Henry S. D'Auria, CFA

Chief Investment Officer—Emerging Markets Value Equities
Henry S. D’Auria is the Chief Investment Officer of Emerging Markets Value Equities, a position he has held since 2002, and Portfolio Manager for the Next 50 Emerging Markets Fund. He served as co-CIO of International Value Equities from 2003 to 2012. Prior to that, D’Auria was one of the lead architects of the firm’s global research department, which he managed from 1998 through 2002. Over the years, he has also served as director of research of Small Cap Value Equities and director of research of Emerging Markets Value Equities. D’Auria joined the firm in 1991 as a research analyst covering consumer and natural gas companies, and later covered the financial-services industry. He was previously a vice president and sell-side analyst at PaineWebber, where he specialized in restaurants, lodging and retail. D’Auria holds a BA in economics from Trinity College and is a CFA charterholder. Location: New York

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