Global challenges in asset management

Global challenges in asset management
Emerging markets shift gears
A report from The Economist Intelligence Unit

Commissioned by


Global challenges in asset management
Emerging markets shift gears

Contents
Introduction

3

From yield to maturity: Development of local currency debt markets

4

Emerging markets: Alpha, beta or bust?

8

Conclusion

11

© The Economist Intelligence Unit Limited 2014

1

Global challenges in asset management
Emerging markets shift gears

About the
report

Global challenges in asset management: Emerging
markets shift gears is based on two webinar
events held by The Economist this year: one
held in Kuala Lumpur on September 3, 2014 and
another held in Dubai on October 27, 2014. The
webinar events and this report are sponsored by
Malaysia’s Islamic Finance Marketplace. The focus
of the event in Kuala Lumpur was local currency
debt markets—their relative maturity, market
trends and obstacles to further development. The
event in Dubai looked at investment strategies in
emerging markets and the relative advantages of
active and passive approaches.
The aim of both events, which were moderated by
a senior editor from The Economist Intelligence
Unit, was to bring together expert panelists
to engage each other in dialogue about how
emerging market investing has become a
challenge to asset managers. The events also
uniquely sought to include Islamic perspectives
on the issues in focus for a more diverse and
robust discussion.

2

© The Economist Intelligence Unit Limited 2014

About the sponsor
Since its introduction more than 30 years ago,
Islamic finance in Malaysia has developed into
a comprehensive and sophisticated Islamic
finance marketplace. Malaysia’s Islamic
finance marketplace is served by the Malaysia
International Islamic Financial Centre (MIFC)
Community, founded on the launch of the
MIFC initiative in 2006. The MIFC Community
is a network of the country’s financial sector
regulators, government ministries and
agencies, industry players from the Islamic
banking, takaful, re-takaful and Islamic capital
market industries, human capital development
institutions as well as professional ancillary
services companies ranging from legal firms and
Shariah advisories to tax and audit firms and
research companies. For more information on
Malaysia’s Islamic finance marketplace, please
visit www.mifc.com.


Global challenges in asset management
Emerging markets shift gears

1

Introduction

One would think that with the S&P 500 in a bull
market and bond yields still generally very low
that asset managers would be struggling to come
up with complaints. Such is not the case.
Today, the global asset management industry
faces multiple challenges, including navigating
central bank policy divergences, finding
sustainable sources of risk-adjusted returns and
managing exposures to myriad risks, including
those stemming from regulatory actions and
political events. Mohamed El-Erian, chief
economic adviser to Allianz and chairman of US
President Barack Obama’s Global Development
Council, recently noted the fund management
industry has enjoyed a wave of central bank
liquidity that broadly boosted asset prices, but
needs to consider life without such extraordinary
support. “The longer the wave persists, the
greater the challenges it poses for the industry
in future. Asset managers would be well advised
to prepare now rather than get caught out when
the wave ultimately breaks,” Mr El-Erian wrote in
commentary published in September.1
Investors in emerging markets (EM) certainly
anticipated the wave breaking last year.

Expectations that the Federal Reserve would wind

down its quantitative easing programme led to
a broad sell-off in EM assets. However, US bond
yields have remained remarkably low, supporting
EM fixed income markets this year.
Underlying fundamentals are difficult to read,
while recent economic data from China and Brazil
have not been particularly promising. Credit
growth in China, which has been a key driver
of economic activity since the financial crisis,
dropped in July, the lowest in more than four
years before rebounding somewhat in August.
Brazil slipped into recession in the first half of the
year. Argentina’s recent debt default, the ongoing
standoff in Ukraine and new political leadership
in India and Indonesia altogether paint a
complicated picture.
This report is focused on the challenges of EM
investing. The supposition is that it is no longer
prudent to treat EM as a single bloc. Growth has
shifted to a lower gear in large EM economies, but
the impact on investment opportunities is not
uniform. Economic fundamentals in these markets
appear to have become more differentiated and
thus investors need to adapt.

Financial Times, “Post-QE
wave to break over fund
managers”, 8 Sept 2014.

1

© The Economist Intelligence Unit Limited 2014

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Global challenges in asset management
Emerging markets shift gears

2

From yield to maturity: Development
of local currency debt markets

For a playback of the webinar, click here

Panel discussion participants:
• Ahmad Najib Nazlan, executive director, Amundi Islamic Malaysia
• Badlisyah Abdul Ghani, chief executive officer, CIMB Islamic Bank Berhad
• Donald Amstad, director, Aberdeen Asset Management
• Mohd Daud Bakar, founder and group chairman, Amanie Advisors
• Kevin Plumberg, senior editor, Economist Intelligence Unit

For many investors, a question mark has hung
over the local currency bond markets since May
2013 when fears of Federal Reserve tapering
triggered widespread volatility. EM local currency
bond funds have suffered net outflows of US$4bn
so far this year, in contrast to EM hard currency
bond funds, which have absorbed net inflows of

US$16.5bn.2

Are local currency bond markets mature enough
to deal with such an outflow of foreign capital?
Are the pools of liquidity deep enough to handle
sudden reversals in the movement of capital and
do these markets have a variety of issuers to
attract an equally diverse investor base? To these
questions, the panellists generally agreed that
local bond markets in emerging economies have

Recovery mode?
JPMorgan GBI-EM index, 2011-2014
Yield (%, left scale side)

Data as of Nov. 6, 2014.
JPMorgan, EM fixed income
flows weekly, Nov. 6, 2014.
2

4

Market value (US$bn, right scale side)

8.0

1,800

7.5

1,700

7.0

1,600

6.5

1,500

6.0

1,400

5.5

1,300

5.0

1,200

4.5

1,100

4.0
2011

1,000

2012

Source: JPMorgan.
© The Economist Intelligence Unit Limited 2014

2013

2014


Global challenges in asset management
Emerging markets shift gears

matured significantly and while last year’s sell-off
was painful, the fact that markets have rebounded
relatively quickly suggest resilience to large
outflows.
“In terms of the way the debt markets have
matured, we have a pretty much full yield
curve,” said Donald Amstad, director of business
development at Aberdeen Asset Management.
Unlike a decade ago, there are a dozen markets

where an investor can buy bonds for any duration
from 1 year to 10 years. It is an important
development because foreign investors can
adjust their duration, or exposure to interest rate
changes, by shifting between maturities and they
can aim for higher returns through more complex
trades that may require buying bonds from one

end of the yield curve while selling bonds on the
opposite end of the curve.

EM local currency debt market at a glance
• Outstanding debt reached US$9.1trn, or 87 percent of total EM debt, as of December 2012.
• Local banks dominate holdings of the asset class, but domestic insurance and pension funds have been
increasing participation in the market.
• Foreign investors on average account for 27 percent of local debt demand.
• Local currency bond funds have seen net capital outflows of US$4bn in 2014, as of Nov. 6.

VARIETY OF INVESTORS
Citing one of the ways that local markets have
matured, Ahmad Najib Nazlan, executive director
at Amundi Islamic Malaysia, said that there are
today a “myriad of investors” including local
pension funds, statutory bodies and central banks
that make it attractive for issuers to tap capital
markets for funding.
Badlisyah Abdul Ghani, chief executive officer of
CIMB Islamic Bank Berhad, said that the market
in Malaysia is deep enough to ensure adequate
demand for ringgit-denominated bonds.
The depth of Malaysia’s bond market has two
implications, he said. First, there is little need for
Malaysian companies to tap foreign bond markets
unless they require foreign currency for their
businesses. Second, some foreign issuers have
become keen on tapping the local investor base in
Malaysia for funding and swapping the proceeds
into other currencies.

Investors in Malaysia also have a strong appetite
for sukuk issues, another key component of

the local debt market. Often referred to as the
Islamic equivalent of a bond, sukuk is a structure
in Islamic finance that grants investors a share
of an asset, which the investor rents back to the
issuer for a rental fee. This structure is permitted
by Islamic law, as opposed to traditional bonds,
which involve the charging or paying of interest.
The continuing strong appetite for sukuk among
Malaysian investors could encourage a greater
number of Malaysian companies to tap this
market, Mr Ghani said.

A NEED FOR BETTER TOOLS
Malaysia has the largest local currency sovereign
debt market in the ASEAN region. But emerging
markets as a whole contain many different levels
of maturity.
Moreover, many local bond markets still need
better tools to provide investors with more
flexibility. Mr Nazlan said: “There are aspects of
these markets that have to be developed further,
in terms of risk management tools, the interest
rate swap market, the currency swap markets.”
© The Economist Intelligence Unit Limited 2014

5

Global challenges in asset management
Emerging markets shift gears

We are going to see
more corporates,
including some of
the larger SMEs—
who previously only
tapped the banking
sector—coming
to tap the bond
market.
Badlisyah Abdul Ghani,
CIMB Islamic

The fact is that by definition local currency bond
markets have inherent currency risk, which
make them a riskier proposition than bonds
denominated in US dollars or euros. This may
deter foreign investors with strict constraints
from participating in local currency debt
markets. Governments in some cases may want
to offer incentives such as the provision of swap
arrangements for foreign investors looking to
invest in currencies other than hard currencies,
Mohd Daud Bakar, founder and group chairman of
Amanie Advisors, said. He added that advanced
swap programmes are needed to allow foreign
investors to take a longer term view of a market

for without them, it can be challenging for them
to invest. “We have to facilitate the risk appetite
of foreign investors,” he said.

CORPORATES COME TO MARKET
In another sign of the increasing maturity of the
local debt markets, EM companies are expected
to increase their home currency bond issuance,
offering investors a much greater array of choices.
This is where panellists believe the next phase
of development for the industry lies. Mr Amstad
said that corporate bonds currently tend to be
relatively illiquid and expensively priced.
Outstanding local currency corporate bonds
grew over 10 percent in USD terms in 2012 to
US$6.8trn, though the bonds are not heavily
traded and pricing not always so transparent.3

Ashmore, Growing
opportunities in emerging
market corporate bonds,
March 2014.

In Islamic finance, non-sovereign sukuk issues
are also expected to grow, as a greater variety
of “borrowers” become comfortable with the
non-traditional structure. For established sukuk
funds and bond funds with constraints that
would allow allocation to sukuk, the potential for
added portfolio diversification is likely attractive,

particularly after the UK’s first sovereign sukuk
issuance in June and Goldman Sachs’ announced
plans to issue sukuk. Standard & Poor’s Ratings
Services forecasts issuance of corporate and
infrastructure sukuk in the Gulf Cooperation
Council (GCC) and Malaysia to increase over the
next few years, owing to growing refinancing
needs of companies and as more organisations
establish themselves as issuers of sukuk.

GLOBAL FACTORS IN LOCAL
MARKETS

However, companies should increasingly be
able to get longer-term financing from the bond
markets domestically rather than having to rely
on banks. “We are going to see more corporates,
including some of the larger SMEs—who
previously only tapped the banking sector—
coming to tap the bond market for financing,” Mr
Ghani said.

The near-term outlook for local currency bond
markets may hinge on factors that are beyond
the control of local governments. The US Federal
Reserve is widely expected to raise its benchmark
interest rate in 2015, and the European Central
Bank (ECB), which is struggling to avoid deflation,
could turn to full-blown quantitative easing (QE).

The growth of local currency corporate bond
markets will also bring new risks. For example,

The Federal Reserve’s asset buying programme
ended in October and the EIU predicts the
benchmark Fed funds rate will rise during the

3

6

new EM corporate bond issues may not be rated
by one of the main credit rating agencies on
which global investors rely. Unrated bonds can
be cheaper than rated ones and thus hold the
potential for investors to find value. However,
picking and choosing between unrated bonds
requires capabilities to conduct in-depth credit
analysis and awareness of the differences
between the advanced and EM landscapes. For
example, in EM, there is significantly less clarity
about the rights of bond holders in the event of a
bankruptcy of the bond issuer compared with the
US market.

© The Economist Intelligence Unit Limited 2014


Global challenges in asset management
Emerging markets shift gears

second half of 2015. Rising interest rates risk
triggering outflows from local currency bonds, as
the gap between local interest rates and US rates
shrinks.
ECB action could actually provide a countervailing
force if it unleashes QE of its own, following in
the footsteps of the central banks of Japan, the
UK and the US. Such action could add significant
liquidity to global markets.

A SEISMIC EVENT
In Asia, the panellists expect two events will
mainly shape the long-term outlook on local
currency EM bonds. The first is the opening of the
capital account and capital markets in China — a
“seismic event” for the global financial system,
said Mr Amstad, who compared its importance
with the launch of the euro. The size of China’s
economy means its deeper integration into the
global financial system will significantly change
global capital flows.
Considering that China is currently not a
constituent of various benchmark bond indices,
the opening of the country’s capital account will
have a major bearing as China’s weight in indices
is going to be “extraordinary”, according to Mr
Amstad. The domestic bond market in China
today, for instance, is worth US$3.5trn. To put

that in perspective, the JPMorgan Emerging
Market Bond Index, the GBI-EM and the Corporate
Emerging Markets Bond Index put together had a
combined market cap of US$2.8trn as of the end
of 2013.
The second event that could shape the outlook
for local currency bonds is the formation of the
ASEAN Economic Community (AEC), which is
officially scheduled to come into being in 2015.
Though the timetable is uncertain, the AEC is
expected to have a profound impact on ASEAN’s
local bond markets. Mr Nazlan said closer
integration between economies and markets in
South-east Asia should theoretically result in
greater transparency in bond pricing and freer
flow of capital across borders.

The opening of
China’s capital
account and capital
markets will be a
“seismic event” for
the global financial
system.
Donald Amstad, Aberdeen
Asset Management

Integrated local debt markets in ASEAN would be
an exception rather than the rule. The panellists
agreed that while local bond markets have

generally matured significantly over the past
several years, they remain fragmented on the
basis of their different market structures. These
markets remain highly idiosyncratic, but for
active investors that may be a source of potential
alpha—or above-benchmark returns. Indeed,
the growing maturity of local bond markets may
require investors to reconsider which strategies
are the most effective.

© The Economist Intelligence Unit Limited 2014

7


Global challenges in asset management
Emerging markets shift gears

3

Emerging markets: Alpha, beta or bust?

For a playback of the webinar, click here
Exclusive one-on-one interview:
• Mark Mobius, executive chairman, Templeton Emerging Markets Group

Panel discussion participants:
• Wan Kamaruzaman Wan Ahmad, chief executive officer, Retirement Fund Incorporated (KWAP), Malaysia
• Andrew Goldberg, global market strategist and head of the market insights strategy team in Europe,
JPMorgan

• Gaurav Mallik, portfolio strategist, active emerging markets investment team, State Street Global Advisors
• Andreas Zingg, director, head of iShares Middle East & Africa, BlackRock
• Kevin Plumberg, senior editor, Economist Intelligence Unit

Market volatility in late October, following Dilma
Rousseff’s narrow victory in Brazil’s presidential
election, was a good example of one of the main
challenges of investing in EM. Ms Rousseff’s win
– interpreted by investors as detrimental to the
broader economy - immediately sent the markets
in a spin. Brazil’s real fell 3.1 percent against the
US dollar in a single day to its lowest level since
May 2005 and the Sao Paolo stock market slumped
6 percent. What is the best approach to navigating
these markets: actively managing a portfolio or
using a passive approach?
Brazil is also a good example of an EM economy
seeing growth slow considerably. That only has
made the question of what investment strategy
to use even more pertinent. Active investors
often say that their approach makes a lot of sense
in EM because of the inefficiencies in markets
that can be exploited by a skilled investor.
Andrew Goldberg, global market strategist
with JPMorgan, said developing economies are
8

© The Economist Intelligence Unit Limited 2014

not a bloc, and “it’s important to drill down,

differentiate and know, for example, who’s
more susceptible to rising rates in the US versus
who’s more insulated”. Isolating the impact of
growth in the US, Europe and Japan on EM, for
example, shows that individual EM countries
are affected differently, depending on whether
they are commodity exporters or manufacturing
economies.

DIFFERENTIATORS
Differentiation is certainly part of Mark Mobius’
approach to pursuing EM opportunities. Mr
Mobius, executive chairman of Templeton
Emerging Markets Group, said the markets in
which he has the highest conviction are China,
India and several frontier economies. Drilling
down further, Mr Mobius is focused on the banking
sector as a way to access the growing wealth of
consumers. He also is focused on the leisure and
healthcare industries.


Global challenges in asset management
Emerging markets shift gears

An advantage of stock pickers is that they can
potentially root out opportunities that others
overlook. In this respect, frontier markets,
including those in Africa and the Middle East,
are where Mr Mobius has been paying more

attention lately. Yet why couldn’t an investor
seeking more exposure to frontier markets, which
are essentially aspiring emerging markets, buy
exchange-traded funds (ETFs) for a much lower
cost than buying an actively managed fund?
That question summed up a dilemma in the asset
management industry today, but it was also an
area where Mr Mobius recommended caution,
particularly when it came to frontier markets.
As frontier market ETFs grow in size, it will be
increasingly difficult for them to replicate an
underlying index of relatively illiquid markets
without creating an unwanted market impact.
“Going into frontiers with ETFs would be a dicey
and risky adventure,” Mr Mobius said.

PASSIVE AGGRESSIVE…
Regardless of the debate over frontier market
ETFs, passive strategies are being increasingly
deployed by investors to get wider exposure
to the macro fundamentals of EM economies.
Proponents say instruments such as ETFs enable
investors to have a greater diversity of exposures
across EM at a lower cost than actively managed
funds.
Furthermore, passive investing is not just
about putting one’s money in an index or ETF
and waiting for it to rise. So-called smart beta
investing involves creating tailored indexes
that are not based on the traditional criterion

of market capitalisation. Andreas Zingg, head of
iShares Middle East & Africa with BlackRock, said
smart beta strategies are a way to manage – and
even benefit from – the rise in volatility that EM
stocks have seen in the past year. A minimum
volatility index is designed to outperform broader

markets in adverse conditions. Mr Zingg pointed
out that in the past three years the iShares MSCI
EM Minimum Volatility Index outperformed its
parent index by more than 15 percent.

...OR HYPER-ACTIVE?
On the flipside, active investment strategies,
although more costly, enable investors to exploit
opportunities that arise as a result of market
imbalances and differentiated economic growth
rates across EM. The belief of the active investor
is that the increase in price volatility in EM bonds
and equities as well as the divergent economic
growth trends are ideal conditions for a skilled
manager to sift through assets being unloaded in
a hurry to find interesting opportunities.
Gaurav Mallik, portfolio strategist at State Street
Global Advisors, said that even in developing
economies that are witnessing healthy growth
rates and sound fundamentals, it is important to
identify the drivers. In India, for instance, most
of the growth has come from consumer-oriented
sectors, so a recovery may eventually spread to

the industrial and financial sectors. An active
manager would thus drill down in these sectors
and filter opportunities.

Going into frontiers
with ETFs would be
a dicey and risky
adventure.
Mark Mobius, Templeton
Emerging Markets Group

In terms of how investors have been accessing
active opportunities, Mr Mallik said regional,
country-specific and small-cap funds have been
popular, with the latter being a more recent focus.
Mr Zingg from BlackRock added that investors
have been increasingly interested in regional and
single country EM ETFs as well. However, timing
bets on the market by using country-focused ETFs
is difficult to get right. Active stock selection can
face the same challenges of market timing, but
allows investors to manage the impact of currency
fluctuations on international investments. EM
currencies have been a significant source of
market volatility in the past year.

© The Economist Intelligence Unit Limited 2014

9

Global challenges in asset management
Emerging markets shift gears

Diverging markets
Currencies vs the US dollar, September 1st, 2013=100
Russian rouble

Indian rupee

Indonesian Rupiah

Turkish lira

Brazil real

South African rand

110

110

105

105

100

100

95

95

90

90

85

85

80

80

75

75

70

70

65

65
60

60

Sept
2013

Oct

Nov

Dec

Jan
2014

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Source: Thomson Reuters.

THE RIGHT MIX?
Ultimately, the choice of whether to use an
active or passive investment strategy in EM is
based not only on the strength of the approach
but also on an investor’s objectives. Achieving
investment targets may involve a mix of alpha
and beta strategies based on their tolerance of
risk, such as multi-asset strategies. While such
a mixed strategy could result in diluted alpha as
well as higher costs of investing, the potential for
portfolio diversification is an advantage.
Mr Goldberg from JPMorgan said a recent example
that has been popular with investors is combining
EM debt and EM equity investment strategies in
pursuit of income.

SHARIAH CHOICES
Wan Kamaruzaman Wan Ahmad, chief
executive of Retirement Fund Incorporated
(KWAP), Malaysia, says the US$33bn fund is
currently invested entirely based on“socially
responsible investing” (SRI) principles. To this
end, Mr Wan added that the fund would be looking
10

© The Economist Intelligence Unit Limited 2014

to hire external managers to further develop
capabilities when it comes to environmental,
social and governance portfolios, otherwise
known as ESG investments.
The fund has recently started investing more in
shariah compliant instruments, too. Shariahcompliant strategies are sometimes included as a
part of the wider universe of socially responsible
investments, because Islamic finance bars
dealing with businesses that engage in sinful or
irresponsible activities – similar to the focus of
SRI portfolios. How those are defined of course
are up for interpretation.
Could KWAP cut costs by investing more in passive
strategies? Possibly, but creating more ETFs that
track Islamic indexes is challenging because of a
lack of global or regional standards, said Mr Zingg.
“It is hard to identify standards. That makes it
difficult for us because when we have product
ideas, we share it very early with clients and we
need strong and clear feedback to push the button
and to launch a product,” he added.


Global challenges in asset management
Emerging markets shift gears

4

Conclusion

Our webinar discussions revealed three key
challenges that investors face today when it
comes to global EMs: lower growth in some
developing economies, poor performance
and divergent monetary policies in advanced
economies.
Global economic woes are not expected to abate
anytime soon, and the EIU has consistently
lowered its 2014 and 2015 growth forecasts. We
estimate the global economy will grow 3.1 percent
in 2014, lower than the 3.6 percent forecast in
January. EM economies are expected to post GDP
growth of 4.5 percent in 2014, delivering the
smallest premium over developed economies since
2000. If they haven’t already, asset managers
will likely have to become accustomed to slower
growth and increased fragmentation in EM.

The question of which investment strategy to
use in EM will continue to be a vital one, though
investment objectives should ultimately be the
deciding factor in whether to use an active or
passive approach. Asking which is better, an
active or passive approach when it comes to EM
investing, is a false dilemma and really depends
on what investors are aiming to achieve. For
example, Mr Wan from the Malaysian public
pension fund KWAP says that his fund would
likely outsource active strategies that do not

use benchmarks while bringing back some
benchmark-driven mandates in-house to manage
costs.
In addition, many asset managers are exploring
blended strategies as a way to meet their clients’
targets.

Yet, slower economic growth has not had an
impact on the development of local debt markets.
While local bond markets witnessed a large selloff last year, they saw a quick rebound, suggesting
growing maturity and resilience. EM corporate
bond issuance has also continued to grow and
offer investors a wider variety of investments.

An area that could have a significant bearing on
EM prospects is structural reforms to manage
economies more efficiently. Today’s slower growth
may act as a catalyst for these policy-led reforms,
perhaps leading to better infrastructure in India,
more consumption in China and more competitive
manufacturing in Brazil and Russia.

The growing prominence of Islamic finance
is promising too, with increased demand for
shariah-compliant investment instruments from
traditional investors as well. Sukuk issuance, both
sovereign and non-sovereign, has expanded,
providing more portfolio diversification
opportunities to a wider group of investors.

Developing economies account for more than 35
percent of the global GDP, but only 20 percent
of global equity and 12 percent of global bond
markets, suggesting substantial scope for growth.
But investors’ and asset managers’ adaptability
and flexibility will likely be the largest
determinants of EM prospects.
© The Economist Intelligence Unit Limited 2014

11


While every effort has been taken to verify the accuracy
of this information, The Economist Intelligence Unit
Ltd. cannot accept any responsibility or liability
for reliance by any person on this report or any of
the information, opinions or conclusions set out
in this report.


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