Emerging markets: time to throw in the towel or a buying opportunity?, May 2018

Having performed strongly in 2016 and 2017, emerging markets have struggled the past few weeks, with equities, bonds and currencies all taking a knock.

What has caused this crisis of confidence?

The rising US dollar is one reason investors have lost some confidence, the threat of trade wars another. And there have been one or two country-specific events that would cause even the hardiest of investors to flinch: Argentina, for example, has made a number of policy mistakes which have caused its currency to plunge, inflation to spike to 22% and interest rates to rise to an eye-watering 40%!

Why the US has such an impact

Looking at the US dollar first, the problem is that when it strengthens it can lead to tighter financial conditions in emerging markets, as those with dollar-denominated debt see their payments rise. In other words, it becomes more expensive for the them to pay back their loans and this, in turn, can stifle growth. With the US central bank also raising interest rates, it means that the yield on emerging markets' own bonds has to go higher to attract investors. Why would you invest in an emerging market bond paying 4%, when you can invest in the far 'safer' US equivalent and still get 3%?

However, neither our research team, nor fund managers we have spoken to, think this is a reason to throw in the towel.

Emerging markets better placed today than 2013

Back in 2013, when the US central bank first mooted the idea of reversing its quantitative easing programme, emerging markets had what was described as a 'taper tantrum'. Their stock and bond markets sold off in panic at the prospect of the US raising interest rates. A number of economies had big current account deficits to finance and there was a question mark over their ability to do so.

Today, however, with one or two exceptions, emerging markets generally are in much better shape. Their borrowing in most cases is a lot more manageable and some countries even have a current account surplus. While a rising US dollar doesn't help, it is not the end of the world. Commodity prices have also held up well, which helps the oil producing nations, and the 'trade war' with the US seems to have been put on hold for the time being.

The International Monetary Fund has said that it expects emerging markets to grow by some 5% this year and next and their stock markets on aggregate are still looking relatively good value. It's also important to remember that there are a huge number of different economies and stock markets in the emerging market asset class, so some will do better than others.

The Aberdeen Emerging Markets bond team believes that in many ways, emerging markets are still in a sweet spot. Growth is slightly slower but still solid and inflation is yet to pose a threat. They see the recent weakness as a buying opportunity.

How the VT Chelsea Managed funds invest in emerging markets

As investment advisers to the VT Chelsea managed funds, we regard emerging market debt as a satellite position rather than a core holding as it is at the higher end of the risk spectrum. The VT Chelsea Managed Monthly Income fund has around 4% allocated to the asset class, via funds such as M&G Emerging Markets Bond. The manager, Claudia Calich, is a real expert in her field and a very, very good stock picker.

When it comes to equities we tend to have a natural overweight to the region as we are long-term investors. Over the next 20-30 years we think the trends are very positive and we will no doubt add to positions as and when the asset class falls. Some of our favoured funds at the moment are Hermes Asia ex Japan, GSAM India Equity Portfolio, RWC Global Emerging Markets and Henderson Emerging Market Opportunities.

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the fund managers and author and do not constitute financial advice.

Published on 21/05/2018