InvestmentsOct 3 2018

Woodford expects emerging markets struggles to continue

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Woodford expects emerging markets struggles to continue

Rising inflation and Donald Trump's presidency mean the problems experienced in emerging markets were likely to persist, Neil Woodford has said.

Mr Woodford, who runs the £5.6bn Woodford Equity Income fund, has positioned the portfolio for a downturn in global equity markets prompted by a decline in the economic outlook for China and emerging markets in general as interest rates rise.

He said: "Concerns about the health of emerging economies abated somewhat during the month [of September], helped by a slightly weaker US dollar. We are not convinced this will last.

"Tighter global liquidity conditions, as reflected in the strength of the US dollar for much of this year, are already causing considerable pain for emerging markets and we believe the situation will worsen from here."

Emerging market assets tend to perform badly when the US dollar is strong because many emerging market economies and companies must borrow in dollars, so when the dollar rises in value, costs of repaying existing debt or borrowing more rises, leaving less cash for shareholders, to expand businesses, or for government spending.

Last month Mr Woodford said the "stress" seen in emerging markets was proving his view of the world economy right.

He said: "The current policy mix in the US, with Trump’s populist agenda playing out through tax cuts, dollar repatriation and the war on trade, coupled with progressively higher US interest rates from the Federal Reserve, suggest further dollar strength is likely.

"Indeed, with inflationary pressures building in the US, [...] there is an increasing risk that US interest rates could rise faster and further than is currently expected, which would represent an unwelcome surprise for global financial markets."

Over the past three years, the performance of the Woodford Equity Income fund put it in the bottom quartile, returning 2.6 per cent compared to the 31.2 per cent returned by its sector, the IA UK All Companies.

But more recently the fund has outperformed, returning 1.6 per cent over the past three months compared to a loss of 0.7 per cent for its sector.

James Dowey, chief economist and chief investment officer at Neptune said the link between a stronger dollar and poor performance for emerging markets was well established but he expected the relative strength of the dollar to ease.

He said the dollar had been strong in recent months because market participants had realised the global economy was not growing as fast as had previously been expected, so began buying the dollar as a safe haven.

Mr Dowey said the market was now pricing in a lower level of global growth so the need for a safe haven asset such as the dollar had diminished. He added there were signs the Chinese economy was stabilising, which would further boost emerging markets.

Simon Edelsten, who runs the £106.5m Artemis Global Select fund, said the policy of higher interest rates in the US had contributed to a "scarcity of dollars", which was contributing to emerging market volatility. He continued to have little invested in emerging markets.

Adrian Lowcock, head of personal investing at Willis Owen, said: "I like emerging markets and the current sell off is an over-reaction so use the opportunity to buy the dips and start rebuilding exposure to emerging markets.

"However, the asset class is likely to remain under pressure for some time so it is case of drip feeding into the sector and being prepared for some volatility in the short term, especially in the currencies.

"The key risks are slower Chinese growth, a strong US dollar and the growing trade war with the fear of contagion risk as weaker country’s struggle. However, I think fear of contagion is over rated – emerging markets are less cyclical than they once were, not as dependent on commodities and have much less exposure to US dollar dominated debt.

"For longer term investors the asset class was cheap and has just got cheaper still."

david.thorpe@ft.com