Emerging Markets – Are they finally losing their old-world charm?

For the past 50 years since Sir John Templeton discovered emerging markets, they have been a must-have in every global portfolio. They have given above-average returns, diversified asset classes and opened up new frontiers. All that may be changing as emerging markets lose a lot of their old world qualities. In an incisive article in Bloomberg, Mohammed El Erian, the man who built bond trading at PIMCO, raises some interesting questions.

Not an asset class any longer…

For years, the typical charm of emerging markets has been its homogenous nature. Most emerging markets were growing rapidly, were driven by exports and behaved in tandem. Not any longer. Let me illustrate. As the price of oil falls, the countries of the Middle East and Latin America incur losses but India, China and Turkey stand to gain. With a fall in commodity prices, African nations lose but India and China tend to gain. As a result of these fairly divergent trends, it has become difficult to classify these emerging markets as a single asset class. This has created a major problem for ETFs, index funds and passive sovereign funds; which were the biggest investors anyway.

Not so de-risked any longer …

The primary attraction of emerging markets arose from the fact that they were a safe haven for developed nations who wanted to diversify their country risks. It was originally seen in Japan and later in Korea, Singapore, Malaysia and Thailand. Post 2008, with global monetary policies getting synchronized, this de-risking has not happened. Effectively markets across the US, Europe, Japan, India and Latin tend to move largely in tandem with developed markets. That takes away another key attraction of emerging markets.

Vulnerable to capital flows…

Most emerging markets are too vulnerable to capital flows, considering their lack of breadth and depth. Asia witnessed this during 1997 when dollar outflows led to Asian markets losing up to 50% of their values. The contagion of 2008 saw deep cuts across global emerging markets. Again, in 2013, India witnessed deep cuts in the market as funds flowed out due to the Fed proposal to taper its QE. This ensures that the investors in emerging markets become the cause and the outcome; something investors would like to avoid.

Currency is a lot freer now…

Lastly, currencies the world over are a lot freer now. It means most economies have a self-adjusting mechanism. The arbitrage that developed nations enjoyed in emerging markets was due to a fixed currency. With most currencies being convertible, probably, the last area of attraction is gone!

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