Doubt full discount

Emerging market equities look cheap

It is best to buy investment assets when they are cheap. What sounds like a truism can be a helpful guide for emerging markets. Shares in the MSCI basket of companies in the developing world trade at just under 11 times forecast earnings. That's a 28 per cent discount to equities listed in places such as London, New York and Tokyo.

The gap is unusually large. Though the discount widened to 33 per cent in February this year, you have to go back to 2005 to find a similar-sized divergence, figures from Thomson Reuters Datastream show. However, it has been wider. In the 1990s, when the Asian crisis struck while the dotcom boom propelled Western shares upwards, the discount grew to more than 50 per cent.

It's not surprising that there is a difference in valuations. Companies based in emerging nations are more vulnerable to political and currency risks, and less likely to be managed in the interest of public shareholders. Growth is also slowing: the World Bank expects the developing world's GDP to expand by less than five per cent this year.

Even so, long-term earnings growth for emerging market companies will be as good as for the developed world, according to Starmine data. Both are forecast to achieve compound annual growth rates of around eight per cent over the next five and ten years.

It is becoming increasingly hard to generalise about emerging markets. The two countries with the biggest weightings in the 23-member MSCI index - China and South Korea - are as different as they are similar. There's little obvious common ground between Taiwan, Brazil and South Africa, the countries with the next largest weights.

The index also masks a wide range of valuations. Taiwanese and South African shares trade at price-earnings ratios in the mid-teens. Chinese stocks, on a forward earnings multiple of just 8 times according to Starmine, are discounting big doubts about future growth in the world's second-largest economy. They could enjoy striking gains if those risks recede. For different reasons South Korea, which is more developed than developing and trades on a forward price-earnings ratio of 9, looks great value.

Overall, now looks a good time to build up emerging market exposure.