At the start of the year, many professional investors were backing 2019 to be a banner year for emerging markets. As is often the case, things haven’t quite panned out that way.
Nine months later, allocators are looking distinctly wary of EM equities once again. The sudden shift in sentiment sums up the prevailing view on the asset class in recent years: generally downbeat attitudes, punctuated all too briefly by moments of optimism.
That means investing in EM equity funds can often be a frustrating prospect. While intermediaries scanning the globe for attractive stock market valuations may often take a close look at the space, by now they will be conscious that the ‘top-down’ perspective is typically a bigger factor in the region’s returns than ‘bottom-up’ company fundamentals.
In this context, the optimism surrounding the asset class as winter drew to a close may have seemed strange, given the ongoing presence of trade war tensions. There was, however, one good reason for positivity from a macro perspective: US-China worries were superseded by the promise of looser monetary policy from the Federal Reserve.
The market jitters seen at the end of 2018 had convinced many investors that the US central bank would be forced to pause its rate-hiking cycle. A series of increases throughout last year had hurt emerging markets, as the strengthening US dollar made it harder for companies and governments to borrow money.
At the end of January, Fed chairman Jay Powell confirmed the central bank would hold off on further rate rises, and optimism over EM equities surged once again. In the UK, investors put £153m into EM equity funds in February, the most for two-and-a-half years.
Bank of America Merrill Lynch’s global fund manager survey hammered home the point. For the first time in the survey’s history, February saw a long EM equity bias ranked as the most crowded trade worldwide. In a sign of how quickly attitudes had changed, lingering doubts over the asset class meant short EM equities had been the third most popular trade just one month earlier.
But as intermediaries know, consensus brings risks of its own; and so it proved again this year. As of August 12, the MSCI Emerging Markets benchmark was still in positive territory for 2019. But a return of 4 per cent, in local currency terms, is far behind the double-digit returns recorded by US, European and UK indices over the same period.
Factor in currency movements to give a more accurate picture of UK investors’ returns, and the picture is worse still: in sterling terms, emerging markets have also underperformed their Japanese counterparts this year.
As Chart 1 shows, that has ensured the EM benchmark remains below other global indices over the past half decade.
The problem for the asset class this year is that the dollar has not weakened as investors had hoped – despite the Fed cutting rates for the first time since 2008 earlier this summer. Increased nervousness over the prospects for global growth has strengthened the dollar’s safe-haven properties, even as US monetary policy loosens.