Almighty dollar?
Investors tend to be sceptical of the investment case for emerging markets when the dollar is strong, even though such a view is no longer justified by the evidence, according to Sai.
Traditionally, emerging market companies and countries must borrow in dollars, rather than their own currencies, and when the dollar rises, this is often a function of US interest rates rising, and that pushes up the cost of debt repayments, leaving less for shareholders and bond holders in emerging market assets.
Additionally, US interest rates rising typically leads to a slowdown in global growth, and as many emerging market economies are exporters, this harms the returns available.
Sai agrees that investors continue to avoid emerging market assets when these factors are present, but says it is no longer justified.
Winds of change?
One of the reasons Sai says it is no longer justified to treat emerging market assets as inversely correlated with the dollar is the growth of the middle class in emerging markets, meaning developed market consumption matters less, while the increased levels of savings among those populations means there is greater capacity for companies and countries to raise finance in their own currency.
Sai adds that Asian (excluding Japan) equities no longer trade at a “beta greater than one” to global equities, meaning that the performance of those equity markets is no more correlated with the performance of the global economy than are developed market equities.
Kamil Dimmich, emerging market equity investor at North of South, says: “If you look at the performance of emerging markets last year, they only fell about the same as developed markets.
"And within that a number of emerging market economies performed strongly, and the index as a whole was dragged down by China; countries such as Taiwan have big budget surpluses and so are net exporters of capital. The strength of the dollar doesn’t particularly impact them.”
Bokor-Ingram says emerging market countries are generally less indebted now than are developed economies, and that even if emerging markets are more sensitive to a global recession, “the valuations arguably reflect this, with emerging market equities trading at a discount of around 20 per cent relative to developed markets.”
One of the consequences of a stronger dollar is that emerging market central banks often have to put interest rates up in order to keep pace with the dollar, even if this has a detrimental impact on the growth potential of their own economies.
