Rising risk premium has failed to dampen investor enthusiasm for emerging market equities as the risky asset class trades at a deep discount to its peers in mature markets and seems to offer extremely good buys.
Russian telecom operators like Vimpelcom and Mobile TeleSystems, Brazil's state oil firm Petrobas and India's Housing Development Finance Corporation are grabbing investor attention despite concerns over global economic growth, rising interest rates, high oil prices and a slowdown in China's red-hot economy.
"Global emerging markets are trading at 40 percent discount to mature markets, which is not sustainable. The discount has to narrow to more appropriate levels," said Wim-Hein Pals, Rotterdam-based fund manager at Robeco Group.
Patrice Lemonnier, head of emerging equities at Credit Agricole Asset Management, in a note said even after adjusting for country risk premiums, emerging economies are trading at a discount of more than 30 percent.
Fund managers said the sell-off in global equity markets during April and May had brought valuations in emerging market equities to more desirable levels.
Emerging market equities, as represented by MSCI's main index for the sector, have gained about 6.4 percent since May 17, while the broader MSCI world share index added nearly 3.1 percent in the same period.
"Prices have come back sharply since around mid-April in particular. We are now at a period where certain companies look interesting. Corrections in the last three months have helped to bring valuations back to more attractive levels," said Kerrie McEwen, client portfolio manager at J.P. Morgan Fleming Funds.
But Deutsche Bank warned in a research report that a rise in bond yields -- an indicator of rising risk premium in financial markets -- and risk aversion provides a difficult backdrop to the whole asset class.
"Is this priced in? - we doubt it until such time as markets become egregiously cheap," the research report said, adding earnings per share growth is likely to slow in emerging markets from its sizzling rise of 46 percent in 2004 to a more modest 5.0 percent in 2005.
From a valuation perspective, this implies that investors need to be cautious before buying into the sector.
OVERWEIGHT BRAZIL, RUSSIA, KOREA, INDIA
Investors said Brazilian, South Korean and Russian equities were trading at extremely cheap levels, while Indian stocks offered tremendous growth opportunities.
"For our emerging markets equity fund, our key overweights are positioned in Brazil, Russia, Korea and India," McEwen said.
Russia's benchmark RTS index is forecast to trade at a price-earnings ratio of 4.6 times and Korea's KOSPI at 6.6 times. India's blue chip stocks are expected to trade at 12.6 times earnings while a more mature market like the United States' Dow Jones Industrial Average <> is seen trading at 17.9 times earnings, data from Reuters 3000 Xtra show.
Fund managers said Russian mobile operators like Vimpelcom and MTS offer massive growth potential at reasonable valuations.
"Apart from that Gazprom is an interesting story, both from an organic growth perspective and from a corporate restructuring perspective," said Robeco's Pals. "Of course, there's more corporate governance risk compared with Western oil companies but there's serious problems in Shell as well. I would say Russia is not worse than others," Pals said.
Robeco also favoured Indian financial sectors stocks like HDFC, which is benefiting from a take-off in local mortgage lending, and smaller capitalised companies like Bharat Forge, an auto parts maker.
"We are overweight Asia as a region, underweight Africa and underweight Latin America. We are negative from a relative perspective on Eastern Europe and don't hold Hungary, Czech or Poland," Pals said.
By Sabyasachi Mitra
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