The two-year rally across emerging-market assets is just the beginning, according to some of the world's largest investors.
Money managers at shops from Franklin Templeton to BlackRock Inc. are betting that developing-nation stocks and bonds will continue to appreciate in the months and years ahead as they catch up from more than half-a-decade of underperforming U.S. assets.
The bullish calls come amid lofty asset prices globally and growing concern that they aren't sustainable, especially as U.S. central bankers pare the stimulus that helped fuel gains. Even in this context, emerging markets will benefit from stable commodity prices, improving economic growth and balance-sheet repairs since a bout of interest-rate anxiety in mid-2013 spurred a selloff known as the taper tantrum, according to Michael Gomez, who oversees $40 billion in emerging-market debt at Pacific Investment Management Co.
"We still think EM screens fair-to-cheap," Gomez said from Newport Beach, California, where he manages a local-currency bond fund that's outperformed 72 percent of peers in the past year. Any dip in prices "could be a relatively short-lived affair and we have the dry powder to take advantage of it."
Investors have been timid in returning to emerging markets since the taper tantrum, but that's changing. Funds investing in developing-nation debt added $1.3 billion in the week ending Sept. 21, posting inflows in 34 of the past 35 weeks, according to EPFR Global. Stock flows also increased.
Another sign that emerging-market equities still have plenty of room for gains is that the amount of money portfolio managers dedicate to the space is still below levels seen before the 2008 financial crisis, according to Stephen Dover, who oversees $416 billion at Franklin Templeton. He's overweight Brazilian and Argentine stocks on optimism that their political reforms can continue as well as Vietnamese and Indonesian equities on strong growth forecasts.
"The stock market is at an all-time high, but that's because there's no alternative," Dover, Templeton's head of equities and chief investment officer of its emerging-market arm, said from Ho Chi Minh City. "The U.S. has been such a disproportionate outperformer these past few years that there has to be some equilibrium. On a relative basis, emerging markets will likely outperform the U.S. over three to five years."
Developing-nation stocks have jumped 28 percent this year, poised for the best annual gain since 2009, as they approach all-time highs. Sovereign dollar bonds have rallied 8.8 percent and hit record levels this month compared to an average 7.1 percent return for developed-nation notes, according to data compiled by Bloomberg. Emerging-market currencies have climbed to their highest level against the U.S. dollar since October 2014.
