Investors responded by switching allegiances with EM equity exchange-traded and mutual funds recording $26bn of inflows over the past six months, reversing a fraction of the roughly $150bn that was withdrawn since the 2013 taper tantrum, according to EPFR Global data provider. Bond funds have also shown resurgence with a record inflow streak of roughly $2bn in the week of 15 August, while over $20bn has been invested over the past two months.
“Money has flowed back to the sector and there are stronger year to date market performances, but we are in the early stages of mean reversion which means there should be no fireworks and investors should contain their excitement,” says Carlos Hardenberg, portfolio manager, Templeton Emerging Market Investment Trust. “The commodity risk remains as oil prices as well as metals will experience volatility.”
Other market participants are also cautiously optimistic. As Jim Craige, head of emerging markets at Stone Harbor Investment Partners, notes: “Over the last three years, the global
environment, combined with political and geopolitical issues, has not been kind to EM. Many of the same macro and regional risks persist today. However, there are clear signs of stabilisation.”
Craige believes that “convergence” via higher growth to developed markets is not only still valid, but is poised for higher and positive returns going forward, based on current valuations. From a political risk perspective, he notes that “while populism seems to have gained momentum in developed markets as a consequence of an economic slowdown, the opposite seems to be the case in most emerging countries.”
Craige is encouraged by two facts: that most large emerging countries have completed their election cycles and the calendar is clear for the next two to three years while the results in most countries showed strong support for market-friendly reformist administrations.
“Although this has been particularly noticeable in Latin America, the same is true for many countries in Asia and Europe,” he adds.
Lupin Raman, head of EM sovereigns at Pimco also points out that on the whole, political and geopolitical tensions look to be receding. “We are also seeing a shift toward orthodoxy with several business-friendly governments coming into power, including in Argentina, India and Peru. While this is not to say that EM now has low political/geopolitical risk or is immune from these shocks – for example, there are exceptions such as Turkey and Venezuela – these risks look to be stabilising or retreating in certain countries.”
This is the case with Brazil with the initiation of the impeachment process and suspension of President Dilma Rousseff. “Although there is still uncertainty, current acting President Michel Temer has a game plan and growth is bottoming out after two years of recession,” Raman says. “Inflation has turned and the current account deficit is moving in the right direction.”
Raman also sees significant momentum in India with the reforms of Prime Minister Narendra Modi taking hold. This is particularly true of the long-awaited goods and services tax (GST) to replace a raft of different state and local taxes with a single unified value added tax system. The new tax which finally passed is not only expected to cut the red tape but also encourage more investment in manufacturing and boost GDP by as much as 1-2%.
