If you have ever visited an Emerging Market country, you may have two reactions: one of a struggling people with no hope and the other of a world of potential opportunities.
Emerging Markets have had more than enough headwinds over the last few years, resulting from investor mentality to lean towards the “no hope” version of the EM world rather than the opportunities. The other primary debilitating factor was the increase of the US Dollar and rise of dollar-denominated loans to local currency bonds, which peaked from 2011 – 2014. Falling commodity prices and depreciating EM local currencies have also led to significantly underweight emerging market(EM) assets in international portfolios from retail to institutional investors.
Yet, with commodity costs secure and EM currencies supported, EM should accordingly increase, and investors should reflect on whether or not they have the proper exposure to this EM recoil. Investing in EM can come in distinct types, and each asset category and/or country is unique, with a wide range of opportunity and risk. Given the cyclical global environment, certain asset classes, countries and sectors in EM equities look attractive compared to US denominated EM debt and U.S. equities.
From improving economics, EM should benefit the most from a pick-up in global growth, and, of course, demographics over the long-term, which should translate into improving earnings. What’s more, valuations are fair regardless of the rally that began in 2016. Within EM equities, I would recommend to look at cyclical sectors, which leads to a regional prejudice in EM Asia given its higher exposure to such sectors.
EM debt that is local is a bit more idiosyncratic in that I would recommend to favor “high-inflation” countries, for example Russia and Brazil, due to waning inflationary pressures translating into interest rate cuts from central banks. The case for USD EMD is more complex. Through the rally, and EM USD sovereigns carry reasonable interest rate risk for long duration securities. I think that the cyclical bottom for EM assets is behind us, and investors should rethink the appropriate asset allocation for EM markets.