Dubai: Investors have become more discerning on emerging markets exposures as they witness economies recovering at different rates, showed findings from the annual independent survey by CREATE-Research and commissioned by Principal Global Investors, a diversified asset management firm.

This shift in investor sentiment marks another defining moment in global investors’ learning curves. In the 1990s, investors underestimated the inherent risks when sovereign lending gained traction.

This was duly confirmed when the ‘Tequila’ crisis in Mexico in 1994 sparked a contagion in Asian economies like Malaysia and Thailand; culminating in sovereign defaults by Argentina and Russia. In the 2000s, in contrast, investors overestimated the inherent strengths of emerging markets, when their growth dynamics and population dividends hogged media headlines worldwide.

Having gone through the extremes of the growth cycles in emerging markets, investors are on ‘wait and see’ mode, the study said. Conspicuously, in most emerging economies, growth has already halved within its previous 3-13 per cent range.

Their equities have duly under performed the aggregate world index by a stunning 25 per cent in 2013; with Brazil and Russia leading the pack. These negatives are expected to be partially eased by medium term positives, such as growing urbanisation, economic rebalancing and the dismantling of various business practices that act as a drag on economic efficiency.

For a majority of emerging markets investors surveyed there are two critical drivers of asset pricing: slower economic growth (62 per cent of respondents) and the US Federal Reserve’s tapering programme (53 per cent of respondents), which is expected to continue to cast a long shadow around the globe.

Both factors are expected to increase volatility and promote opportunism, increasing the propensity for investors to view and use emerging market equities and bonds as part of a tactical investment, rather than the strategic ‘buy and hold’ allocation of just two years ago.

“Economic performance and US monetary policy may be expected to depress market valuations in the short term, but pockets of under-valuation will prevail in all markets. Investors believe that volatility will likely become even more of a unifying theme; therefore, guidance from high conviction specialist managers will be even more necessary,” said Wassim Nasrallah, Managing Director, Head of Middle East at Principal Global Investors.

For the Middle East investors the fabric of emerging markets has changed with the inclusion of the UAE and Qatar into the MSCI Emerging Markets Index. With the anticipated increase in institutional investors, the need for alternative investment instruments has become apparent in line with greater market sophistication.

Despite such a change, the CREATE-Research showed that Middle East investors still remain focused on core asset classes, such as real estate, private equity and actively managed funds. In addition, the growth in awareness of Exchange Traded Funds (ETFs) is also gaining traction, but only with investors focused on opportunistic strategies.

The report also highlighted that nations within emerging and frontier economies are increasingly starting to showcase unique attributes that work against geographical correlations. Dubai is emerging as a regional logistics and tourism hub, whereas Saudi Arabia has shown a trend towards petrochemicals, and India in defence equipment.

“While emerging markets in the East continue to converge with developed markets in the West, it is clear from our research that they themselves will no longer move in lock step. Emerging countries, with their youthful populations and historically strong GDP profiles, will follow different trajectories over the rest of this decade as each market develops a more unique identity and reform fingerprint,” said Professor Amin Rajan, CEO of CREATE-Research and the author of the report.

Despite the rising volatility in the emerging markets, the study found that frontier markets will continue to attract investors. “Frontier markets around the world will continue to excite investors because of their lower correlation with Western markets, favourable macro-economic potential and illiquidity premia,” said Rajan.