A five-point plan for emerging markets


The old joke has it that the definition of an emerging market is a market from which you cannot emerge fast enough when it all goes wrong. Argentina and Chile are 2019’s examples that seem to support this rule, as the former lurched into its latest debt crisis and the latter into a fresh political one, but overall there was no need to rush for the exits.



Top and bottom five EMs in 2019

Source: Refinitiv data. Total returns in sterling, 1 January to 28 November 2019

All of the major regions as a whole – Eastern Europe, Asia, Latin America and the Middle East – are generating positive total returns in sterling for the year and Eastern Europe actually ranks second out of the eight major geographic options available to investors, buoyed by a strong performance from Russia in particular.

However, the good news largely ends there. Eastern Europe may come second but in the same field of eight, Asia, Africa/the Middle East and Latin America are sixth, seventh and eighth.

EMs have generally lagged behind developed markets in 2019

Source: Refinitiv data. Total returns in sterling, 1 January to 28 November 2019

This poor showing, at least on a relative basis, is merely the continuation of a trend that has been evident for most of the decade. EMs have simply failed to compensate advisers and clients for the political and economic risk they have taken. Portfolio builders would instead have been better served by playing it safe and keeping their money in developed arenas such as Western Europe, Japan and, above all, the USA.

“[Emerging markets] have simply failed to compensate [investors] for the political and economic risk they have taken.”


EMs have generally lagged behind developed markets for the whole of this decade

Source: Refinitiv data. Total returns in sterling, 1 January 2010 to 28 November 2019

With the 2020s in mind, advisers and clients seeking to build a diversified portfolio need to consider why EMs have failed to provide adequate risk-adjusted returns and what is needed for this to change.

Five rules

A deeper look at which EMs have performed well and which have not is instructive. There are always exceptions that prove the rule but looking at the full list of EM countries across the past decade, from Thailand and the Philippines at the top to Turkey and poor old Greece at the bottom, five themes look to present themselves.

“There are always exceptions that prove the rule but looking at the full list of EM countries across the past decade, […] five themes look to present themselves.”


There has been a broad spread of EM performance this decade

Source: Refinitiv data. Total returns in sterling, 1 January 2010 to 28 November 2019

  • Economic growth does not guarantee strong equity market performance. Perhaps the best example of this is China, which lurks seventh from bottom in the list of EM nations – with a total return in sterling of just 7% – despite a decade of GDP increases that would slake any Western central banker’s thirst for economic growth.

  • Quality of economic growth does help. Greece boomed in the 1990s and early 2000s but its progress was based on borrowing that proved unsustainable. Turkey has blown similarly hot and cold thanks to its reliance on borrowing and a current account deficit. Both finally hit the buffers. Argentina has also been tripped up by its debts (for the eighth time since 1800, no less). India, by contrast, has relatively low sovereign debt, as do Thailand and the Philippines, which both learned about debt (and especially the dangers of borrowing in overseas currencies) during the 1997–98 Asian crisis. They have taken those lessons to heart – lessons which the West now seems keen to ignore.

  • Currencies and the dollar matter. This takes us back to economic fundamentals. Brazil’s BOVESPA index stands nears its all-time highs at 110,000 but the real has gone from BRL 3.0 to nearly BRL 5.45. Devaluations in Turkey and Egypt have also hurt returns here.

  • Moreover, the last 20 years suggest that a strong dollar is generally bad for EMs and this takes investors back to the issue of debt. Many EMs borrow dollars, so when the buck rises that makes paying the interest more expensive in local currency terms. Argentina has effectively defaulted again, while Turkey frightened many overseas lenders in 2018. A weak dollar would buy a lot of EMs a good amount of breathing space, although that probably needs the US economy to weaken and lose its lustre, perhaps weighed down by its own monstrous budget deficit.

    “The last 20 years suggest that a strong dollar is generally bad for [emerging markets] and this takes investors back to the issue of debt.”


    The dollar appears to have an inverse relationship with EM equities

    Source: Refinitiv data

  • Politics matters. Crude as it sounds, markets are more likely to look favourably upon regions that are going from left to right (as per Greece this year and Brazil since 2018) than the other way round (Argentina being a glaring example). In markets where authoritarian figures are in charge – think Russia – advisers, if they think valuations justify the risks, might like to ask whether their selected fund managers are not better off siding with government-backed firms than their rivals.

  • Commodities matter. This is often dismissed by EM specialists as lazy shorthand and frankly it may well be, especially as some EMs are net exporters and others net importers. But overall, the historic relationship between the Bloomberg Commodity index and the MSCI EM index seems pretty clear.

  • Commodity prices look to have a strong influence on EM equities

    Source: Refinitiv data

    This final chart may be the most telling. This decade can be characterised by low growth, low interest rates and soggy commodity prices. The USA has been the best place to be, as it is packed with technology companies with strong secular growth and is home to the deepest, most liquid markets and the world’s reserve currency. Maybe EMs need a return to cyclical growth and inflation to really shine again.

    AJ Bell Investment Director

    Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.

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