El-Erian: Be Picky on Emerging Market Investing in 2014

Three primary factors were behind the significant underperformance of emerging markets in 2013, says Mohamed El-Erian, and while those specific factors may not recur this year, that doesn’t mean investors should expect an EM recovery that is “broad in scope and large in scale.”

Writing in his Financial Times blog on Wednesday, PIMCO’s CEO and co-CIO said that in 2014, EM investors should rather “differentiate by favoring companies commanding premium profitability and benefiting from healthy long-run consumer growth dynamics.”

Emerging markets’ underperformance in 2013 affected “virtually every asset class,” he reports, including equities, sovereign bonds and the worst-performing asset class, local currency EM bonds, which returned a minus 9%.

El-Erian writes that were some “classic” factors at play in emerging markets last year — revenue that suffered due to “more muted growth and lower government stimulus, with related global demand uncertainties,” lower profit margins and concerns over corporate governance and political instability in certain EM countries. EM equities also weren’t able to take advantage of the “financial engineering” practiced by developed market corporate treasurers who took advantage of G3 central banks’ easy-money policies to buy back shares (he says U.S. companies were authorized to do so to the tune of $750 billion).

Three specific factors also weighed on EM performance in 2013, he says. First was the narrowing of the “EM dedicated investor base,” or as he writes, due to the Fed and other central banks’ actions, “’tourist dollars’ fleeing emerging markets could not be compensated for quickly enough by ‘locals.’”