Skip to main content

The Next 11 countries’ shared vulnerabilities have been exposed by China’s slowdown and anticipation of the Fed’s interest-rate increase.Richard Drew/The Associated Press

This time last year, it looked as if Goldman Sachs Group Inc.'s selection of emerging market up-and-comers was ready to fill the void left by shrinking investment returns in Brazil, Russia, India and China.

Share prices in these "Next 11" countries – places such as the Philippines, Turkey and Mexico – were trading at all-time highs as foreign investors flooded their markets with cash. Inflows into Goldman Sachs' U.S.-domiciled Next 11 equity fund sent assets under management to twice the level of the firm's BRICs counterpart.

Now, though, the Next 11 countries are looking even worse for investors than the larger markets they were supposed to supplant. MSCI Inc.'s Next 11 equity gauge has tumbled 19 per cent this year, versus a 14 per cent slump for the BRIC index.

Foreign capital is rushing out, with the Goldman Sachs fund shrinking by almost half as losses deepened to 11 per cent since its inception four years ago.

The turnaround shows how young populations and a rising middle class – characteristics that first lured Goldman Sachs to the Next 11 economies a decade ago – have failed to safeguard stock-market returns in a world facing higher U.S. interest rates, tumbling commodity prices and a Chinese economic slowdown. For John-Paul Smith, one of the few strategists to accurately predict the losses in emerging markets, it also illustrates the dangers of grouping so many disparate countries into a single investment theme.

Money managers "are increasingly moving away from acronym-based investment," said Mr. Smith, the former Deutsche Bank AG strategist who founded Ecstrat, a London-based research firm, last year.

"Within emerging markets, it is difficult to think of a market that has a combination of attractive valuations and constructive policy developments."

Katie Koch, a managing director at Goldman Sachs Asset Management, said that even with this year's decline, the Next 11 fund's return since its 2011 start still beat the MSCI emerging markets index, which lost 16 per cent during the period.

"While we are certainly disappointed that the asset class headwinds have weighed on N-11, the fund has performed as designed by outperforming broad emerging markets through a full market cycle," Ms. Koch said in a statement.

As investor pessimism spreads to the smaller developing economies, capital outflows are deepening. Exchange-traded funds that invest in emerging markets recorded withdrawals of $1.65-billion (U.S.) in the week ended Sept. 4, a 10th week of outflows. Among the Next 11 markets, funds focused on South Korea and Mexico had the biggest losses. The group also includes Indonesia, Nigeria, Bangladesh, Egypt, Pakistan and Vietnam. Iran is a member, but the Goldman Sachs fund doesn't invest in the country because of international sanctions over its nuclear program.

China exposure

"There's just a lot of negative sentiment," said Geoffrey Dennis, the head of global emerging-market strategy at UBS Group AG in Boston. "There are not many emerging markets that stand out against it, whether it's Next-11 or BRIC. It sucks in every one."

The Next 11 countries' shared vulnerabilities have been exposed by China's slowdown and heightened anticipation of a Federal Reserve interest-rate increase as soon as this month. Weaker Chinese growth has hurt demand for South Korean and Bangladeshi exports, along with the commodities produced by Mexico, Indonesia and Nigeria. Markets in which foreign capital flows play an important role in driving investor sentiment – including Turkey and the Philippines – have slumped on concern international money managers will gravitate toward U.S. dollar assets as the Fed boosts rates.

For Alex Wolf, an economist at Standard Life Investments, country-specific drivers of performance have become too important for investors to rely on groupings such as the Next 11 to determine their holdings.

"There couldn't be bigger differences between these countries: the growth model, the outlook, the demographics and the natural resources," Mr. Wolf said. "You have to look at each country individually."

There are some bright spots. Vietnam's benchmark VN Index has gained 4.9 per cent this year, helped by rising exports and a government push to become an Asian manufacturing hub. Economic growth quickened to 6.4 per cent in the second quarter from 6.1 per cent during the previous three months. Over the longer term, shares in the Next 11 have been a decent bet. The MSCI Next 11 ex Iran GDP Weighted Index climbed 61 per cent including dividends from the end of 2005 through August. That tops a 46-per-cent return from the MSCI emerging markets index.