A combination of factors have resulted in sentiment towards emerging market assets being extremely weak, but a number of fundamental factors may be changing that, according to Emily Whiting, executive director at JPMorgan Asset Management.
She says: “Many investors took the view that with US equities doing so well, why bother with emerging markets? That can be seen in the flows out of the asset class in recent years.”
In addition, Whiting acknowledges that higher US interest rates negatively impact the asset class, for reasons of both sentiment and fundamentals.
The fundamental issue is that higher US interest rates increase the risk-free rate of return on some investments, via owning government bonds.
As the yields on those bonds increases, so the extra risk attached to owning emerging market assets looks relatively less attractive.
The second factor is that most emerging market economies and countries are unable to borrow in their own currencies, and instead borrow in dollars.
Rising US interest rates mean the cost of repaying or refinancing this debt rises, leaving less capacity for those companies to pay dividends, or invest to grow their businesses, or economies.
Whiting says she believes the impact of a higher risk-free return has had a meaningful impact, but that the higher borrowing costs effect is “much softer” in terms of impact than has been the case in the past, as most emerging economies have broader domestic capital markets.
She feels that while investors in developed markets debate the capacity for central banks to cut rates as a way to stimulate economic growth, “many of the emerging market central banks were ahead of their developed market peers in raising rates, and so have more scope to cut now.”
By raising rates ahead of developed market economies, many emerging markets were able to insulate themselves, at least partially, from the impact of dollar strength.
David Jane, who runs a range of multi-asset funds at Premier Miton, is keen on emerging markets right now, particularly because he feels that the next stage of the interest rate cycle will be positive for the asset class.
He says: “My basic hypothesis is we are in a higher-for-longer environment – rates and inflation. And also relatedly we are in a bull trend, higher for longer means higher returns, nominal at least.
"In the early stages, partly as a result of the auto bid from buybacks and index funds this has been driven by the mega-caps. But as things go on the margin flows are beginning to go elsewhere. You can see this in some of the recent moves in Japan, Korea, even H-shares; active managers are starting to reinvest gains in the magnificent seven into other places.
"This is understandable given the spectacularly cheap valuations available in some of these markets – we were buying huge yields that we above their P/E’s in Korea a month or so ago.
"I remain bullish because these markets have a long way to catch up from these levels."
