Strategy Spotlight

RAE Fundamental: Tap into the Performance Potential of Emerging Markets

Portfolio Managers Rob Arnott and Chris Brightman discuss RAE Fundamental Emerging Markets strategy’s strong performance in 2016, their contrarian investment approach, and why they think EM stocks are likely to remain attractive.

More from this section

Read Transcript

John R. Cavalieri, Product Manager, Asset Allocation: Hello, my name’s John Cavalieri at PIMCO. Today I'm joined by Rob Arnott, founder, chairman and CEO of Research Affiliates, and to Rob’s right is Chris Brightman, chief investment officer at Research Affiliates. Gentlemen, thank you for joining us here today.

Rob Arnott, Chairman and CEO, Research Affliates: Thank you.

Chris Brightman, Chief Investment Officer, Research Affliates: You’re welcome.

John: The goal of today is to provide an overview of the PIMCO RAE Fundamental Equity Strategies. And it's taking a bit more of a specific focus on the RAE fundamental EM equity strategy, a strategy that had strong performance in 2016. Could you comment on that, please, as well as outlook going forward?

Rob: Sure. It's not often that I'll speak glowingly about an investment that has risen. As a contrarian that just goes against the grain. But a year ago Chris and I were both out there saying this is the trade of a decade. Well, if it's the buy of a century after the next leg down, it's already the buy of a decade, I don't want to miss that. So I want a meaningful allocation and I want a little bit of dry powder so that I can pile on more if there is another leg down. But I'm not sure there will be.

Lo and behold, January 21 was the low. So, where does that leave us now?

Emerging market stocks are priced at a Schiller P/E ratio of 12. That means they're priced at 12 times their ten-year historical smoothed earnings. 12 times the sustainable long-term earnings. Well, that's pretty cool. US is at 28 times.

So you've got it at 40%. That's pretty interesting. Now, you take that deep discount and you recognize that a year ago it was less than ten times. How often does that happen? We've gone back historically, we've found a couple of dozen examples historically where valuations got below ten on a Schiller P/E ratio, and not cherry-picking the bottom tick, just taking the first month after it went below ten and asking what happened over the next five years? On average the return was 120% over the next five years.

So is this run-up that we've seen the end or the beginning? I think it's more likely the beginning. Now, you have a second dynamic at work.

We had a five-year grinding bear market in emerging market stocks from 2011 through 2015. Just brutal and for all of the obvious reasons. Bargains always exist for a reason. They exist because people legitimately have a narrative that frames their fear, and that narrative has big elements of truth to it.

So you don’t find bargains in the absence of legitimate fear. But it's the legitimate fear that creates the bargains. When you have that legitimate fear, the spread between growth and value can also become unusually wide. So while the Schiller P/E ratio for emerging markets went below ten, the Schiller P/E ratio for fundamental index in emerging markets, dipped well below six times earnings.

John: Because of the value tilt.

Rob: Yes. The value tilt and the huge spread between growth and value. If you take the emerging market stock market and just take the 30% that's cheapest and the 30% that's most expensive — let's ignore the middle 40 — these are the value stocks, these are the growth stocks. The valuation spread between those a year ago was ten to one, ten to one spread. Just enormous.

So it represented an extraordinary opportunity. Were people willing to pile in? No, they were fleeing in droves. That's human nature. So where are we now?

Well, at the very bottom tick of the Great Depression, US stocks briefly, for a few days, went below six times. Emerging markets were distinctly cheaper last January, fundamental index in emerging markets were priced cheaper than that a year ago. They're still priced under eight times.

So you have valuation in your favor. You have, you now have momentum in your favor. When the market’s in freefall, you don't know where the turn is. You want to slowly but surely nibble your way in, because you don't know where the bottom’s gonna be. And as a contrarian you have to be willing to look a little stupid, buying a little too early and buying a little more as it goes against you, in order to have maximum exposure at the turn.

Now, in addition to valuation and momentum, you also have macroeconomic conditions which are improving.

The economic conditions in emerging markets are distinctly better than they were a year ago.  And in all likelihood are going to be better 12 months from now than they are today. We wrote a paper called “The Emerging Markets Hat Trick” in which we identified three factors at work here that make emerging markets notably attractive and notably interesting. So I think we're in the early stages of what's likely to be a long run for these asset classes to give us very respectable long-term real returns.

I've been called a perma-bear. I'm not a perma-bear when something gets this cheap, that's for sure.

John: Great. Well, on behalf of Rob Arnott and Chris Brightman, Thank you.

For more insights and information, visit pimco.com

Filters: Reset All

Filters

Close Filters Dropdown
  • Tags

    Reset

    Close
  • Category

    Reset

    Economic and Market Commentary
    Investment Strategies
    Bond by Bond
    Viewpoints
    Careers
    Education
    PIMCO Foundation
    View from the Investment Committee
    Close
  • Order By

    Reset

    Alphabetical
    Most Recent
    Close
() filters applied

Video Finder

Filter By:
  • Economic and Market Commentary
  • Investment Strategies
  • Bond by Bond
  • Viewpoints
  • Careers
  • Understanding Investing
  • View from the Investment Committee
  • A
  • B
  • C
  • D
  • F
  • G
  • H
  • I
  • K
  • L
  • M
  • N
  • P
  • R
  • S
  • T
  • W
Clear
Tina Adatia
Fixed Income Strategist
Olivia A. Albrecht
Head of ESG Business Strategy
Mike Amey
Joshua Anderson
Head of Global ABS Portfolio Management
Robert Arnott
Founder and Chairman, Research Affiliates
Andrew Balls
CIO Global Fixed Income
Justin Blesy
Asset Allocation Strategist
David L. Braun
Head of US Financial Institutions Portfolio Management
Nathaniel Brown
Erin Browne
Portfolio Manager, Asset Allocation
Libby Cantrill
Executive Office, Public Policy
Laura Deneke
Sr. Vice President, Product Strategist
Pramol Dhawan
Head of Emerging Markets Portfolio Management
Joachim Fels
Global Economic Advisor
David Fisher
Head of Traditional Product Strategies
Gene Frieda
Global Strategist
Adam Gubner
Portfolio Manager, Distressed Debt
Mary Hoppe
Daniel H. Hyman
Head of Agency MBS Portfolio Management
Daniel J. Ivascyn
Group Chief Investment Officer
Mark R. Kiesel
CIO Global Credit
Christine Long
Nicola Mai
Portfolio Manager, Sovereign Credit Analyst
Jason Mandinach
Alternative Credit Strategist
Scott A. Mather
CIO U.S. Core Strategies
Mohit Mittal
Portfolio Manager, Liability Driven Investment and Credit
Alfred T. Murata
Portfolio Manager, Mortgage Credit
John Murray
Portfolio Manager, Commercial Real Estate
John Nersesian
Head of Advisor Education
Sonali Pier
Portfolio Manager, Multi-Sector Credit
Lupin Rahman
Head of EM Sovereign Credit
Libby Rodney
Steve A. Rodosky
Portfolio Manager, Real Return and Long Duration
Emmanuel Roman
Chief Executive Officer
Steve Sapra
Client Solutions & Analytics
Jerome M. Schneider
Head of Short-Term Portfolio Management
Marc P. Seidner
CIO Non-traditional Strategies
Sapna Shah
Head of Corporate Responsibility
Greg E. Sharenow
Portfolio Manager, Real Assets
Anmol Sinha
Fixed Income Strategist
Cathy Stahl
Global Head of Marketing
Christian Stracke
Global Head of Credit Research
Geraldine Sundstrom
Portfolio Manager, Asset Allocation
Richard Thaler
Distinguished Service Professor of Economics and Behavioral Science at the University of Chicago's Booth School of Business
Mark Thomas
Account Manager, Global Wealth Management
Jessica K. Tom
Senior Credit Analyst
Eve Tournier
Head of European Credit Portfolio Management
Jamie Weinstein
Portfolio Manager, Head of Corporate Special Situations
Tiffany Wilding
North American Economist
Andrew T. Wittkop
Portfolio Manager, Treasuries, Agencies, Rates
Chris Brightman
PIMCO
  • Alphabetical
  • Most Recent
Section : Date : Experts :
Reset All
The Bolstering Effect of Fixed Income
Resilient Returns in Equities and Credit
Finding Value on the Uneven Road to Recovery
Five Characteristics of a Post-COVID World
The Long Climb to Recovery

Load more results Load {{cCtrl.fetchResults}} more results

PIMCO
EU

Europe

[change]