Brazil, Mexico, Pakistan, and now Turkey – a series of currency crashes and political instability has forced investors to take another look at their emerging markets investments, as the once-hot sector shows its vulnerability.
Emerging markets have traditionally been seen as a high-risk, high-return alternative to blue-chip equities. These are high-growth markets, which are not too closely tied to influential economies such as the EU, UK and US. This means that when developed markets underperform, emerging market returns may be able to offer some relief.
For more than a decade, investment advisors and institutional investors alike have championed emerging markets debt and equity investments as a way of adding diversity to the average portfolio in times of economic uncertainty, while (hopefully) chasing double-digit gains.
And for a long time, this strategy paid off. In 2009, as the world’s most developed economies suffered from the knock-on effects of the global financial crisis, the MSCI Emerging Markets Index returned a massive 78.51 per cent for the year. Likewise, while the US and the UK dealt with Trumponomics and Brexit, respectively, MSCI’s emerging markets index returned 11.19 per cent in 2016, and 37.28 per cent in 2017.
However, at the end of the first quarter of 2019, these norms appear to be shifting. Economic growth is still sluggish in the UK, EU and US, and emerging markets are also starting to struggle.
In February 2019, the MSCI Emerging Markets Index returned a paltry 0.22 per cent, against 3.01 per cent on the sprawling MSCI World Index. In the 12 months from 28 February 2018 to 28 February 2019, MSCI’s emerging markets index lost 9.89 per cent in value.
The finance community has offered numerous theories to explain the cooling off of the emerging markets space. First, there is the ongoing effect of global economic instability. For instance, the US trade war with China has pitted the world’s largest developed economy against the world’s most influential emerging market economy, with both sides ultimately losing out.
Secondly, a recent run of elections in significant emerging market economies such as Brazil and Mexico have upended those countries’ investment plans. In Mexico, the left-wing leader Andres Manuel Lopez Obrador has increased public spending, placing the country’s credit rating at risk. And in Brazil, far-right disruptor Jain Bolsanaro has concerned investors by placing the country’s welfare reform bill under threat due to inaction.
Turkey, meanwhile, is experiencing massive currency devaluation due to a combination of upcoming local elections and ongoing debt problems in the country. And in Pakistan, the cumulative value of the country’s stocks has fallen under MSCI’s required ‘Emerging Market’ threshold for the first time ever, raising concerns that it could be relegated to ‘Frontier Market’ status.
All of these developments are weighing heavily on the fixed asset investments of emerging market investors across the world, and there is no sign that this is due to change any time soon.
For experienced investors, this is all part of the emerging markets risk/reward balance. But for risk-averse portfolios, it may be time to diversify elsewhere.