The outlook for emerging markets

However, in this instance, it may be the reasons emerging markets have been growing in 2017 will also give investors a clue as to the outlook for these markets over the next 12 months.

Daryl Liew, head of portfolio management at REYL Singapore points out: “Emerging markets have enjoyed a stellar run so far in 2017, amid a favourable environment of a recovery in global economic growth, low inflationary pressures and a weak US dollar. 

“These conditions will likely continue to hold for the rest of the year which suggests that emerging markets could continue to head higher.”

As discussed earlier in the guide, grouping together emerging market economies into the BRICs or emerging Europe can make it harder for advisers and investors to differentiate between the opportunities in the different countries.

While we cannot assume all economies are moving in the same direction, there are enough signs to indicate the asset class is more resilient that it was even three years ago.Alejandro Arevalo

So for Alejandro Arevalo, fund manager, emerging market debt at Jupiter Asset Management, the outlook is largely mixed. 

“While we cannot assume all economies are moving in the same direction, there are enough signs to indicate the asset class is more resilient that it was even three years ago,” he suggests. 

“On the one hand, we have several countries with improving political and macro backdrops that are helping their growth trajectory and investor sentiment towards them, such as Argentina, Indonesia and India. 

“On the other hand, we have several others that have upcoming political and/or economic issues.

"The latter includes Venezuela, likely to default or need to restructure its debt fairly imminently; South Korea and Japan, which are suffering from tensions with North Korea; China, which is trying its utmost to prevent its credit bubble from bursting; and Brazil, which is still reeling from the corruption issues that are stalling its recovery.”

Political risk

Political concerns are often at the forefront of investors’ minds when investing in emerging markets.

While there are many portfolio managers who believe geopolitics can and should be overlooked, it is worth understanding what potential political headwinds face the emerging markets economies, particularly when they go hand-in-hand with the economic outlook.

The rising tensions in North Korea have been hard to ignore recently as the country continues to test missiles and nuclear weapons, in spite of global condemnation, including from some of the BRIC countries, China and Russia.

Mr Liew suggests geopolitics is arguably the biggest risk to this asset class at the moment, pointing to potential military conflict in the North Korean peninsula.

“In this regard, North Asian markets are probably most at risk due to their relatively high exposure to global trade and their geographical proximity to North Korea. 

“China H-shares (8.1 times forward PE) and Korea Kospi (9.2x) are among the cheapest stockmarkets in Asia, probably already factoring in part of this geopolitical risk premium,” he explains.

“However, these markets will likely come under selling pressure should these risk events materialise, possibly correcting 20 per cent, like the initial hit Japan’s Topix suffered when the Tsunami struck in 2011.”

Others are more sanguine about the prospect of an escalation in the threat from North Korea and any action the US might take.

Jan Dehn, head of research at Ashmore Group, dismisses it as nothing more than “a release of geopolitical gas made pungent by the stagnant air in the summer lull”.

He adds: “We do not expect a nuclear conflagration to materialise, and repricing of global asset prices is therefore not justified – it is a good time to pick up assets at a discount. If we are wrong, of course, the repricing of global assets will be far greater, and so the current pullback offers no real protection anyway.”

Global growth engine?

For many, question marks hang over China, which has built up an enormous amount of debt.

Much of this debt is state-owned though, so are investors right to be worried? 

In early 2016, heightened concerns over a so-called ‘hard landing’ in China due to its debt problem caused global stockmarkets to stumble.

Ross Teverson, head of strategy, emerging markets at Jupiter Asset Management, views China’s debt burden as a more significant risk than any political concern.

But Wei Li, head of EMEA investment strategy at iShares, is far more optimistic.

He observes: “China – one of the key global growth engines – has managed to deliver resilient growth year-to-date which allowed Chinese authorities to reduce fiscal support and crackdown on the shadow banking system. 

“Reform momentum, such as supply side reforms in China and the introduction of the Goods and Services Tax in India, should provide sustainability for growth momentum in the mid to long-term.”

Sergey Dergachev, lead portfolio manager, emerging market debt, at Union Investment notes investors in emerging market fixed income products are still compensated for the associated political and liquidity risks compared to other developed market asset classes.

He says of emerging markets more generally: “There are many positive features: growth should stay at around 4.8 per cent, inflation is under control and third, new issuance of EM sovereign and corporate debt is strong and will most likely break the record of 2014 and 2015.”

Staying in EMs

Investors in emerging markets are naturally going to be those with a long-term time horizon. Advisers will know those of their clients who are in emerging markets are those with decades of investing to go, rather than just a few years.

This is important to keep in mind in order to remain invested in emerging markets and not to pull out at the slightest sign of disturbance in one country, or a looming political crisis.

Mr Teverson points out: “While some investors have shied away from markets such as Brazil and Mexico because of the very negative headlines around corruption and US trade relations respectively, these markets are home to some of the best performing emerging market stocks of the past year and, in our view, continue to offer a number of very attractive opportunities. 

Most of the time volatile periods are the best entry points for expanding EM exposure, and this time it is no different.Sergey Dergachev

“North Korea is currently another area of concern for investors. However, looking back over the past decade, almost every year North Korea has managed to generate very worrying headlines.”

He emphasises those investors who react to these negative headlines or avoid opportunities in the region because of them would have made a significant dent in their returns. 

Mr Dergachev says many of the political shocks in emerging markets have not strayed much beyond the respective country’s borders, with limited contagion to other Ems. 

But he asserts 2018 will be an interesting and crucial year for emerging markets, noting “Mexico, Brazil and Russia will have significant political elections, but most likely key political risk to EMs will come from developed market risk events and from China”. 

He adds: “Most of the time volatile periods are the best entry points for expanding EM exposure, and this time it is no different.”

eleanor.duncan@ft.com