5 Things to Know About Emerging Markets

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Emerging market fixed income is less concentrated than equities

Emerging markets debt and equity have many overlapping traits, but also differ in their exposure to countries and risks. The MSCI Emerging Markets Index contains 27 countries, with the five largest accounting for 70% of market value. Three countries in Asia - China, South Korea and Taiwan - comprise more than 50% of the index.

Compared to equities, the fixed income universe is more diverse. The JP Morgan EMBI Global Index, which includes dollar-denominated debt issued by emerging market countries, contains 66 countries. The largest five countries account for only 40% of market value, and the top three for 28%. Of the 66 countries in the emerging market fixed income benchmark, only 19 countries overlap with the equity universe.

"EM equity and debt are distinct asset classes. Investors should allocate between the two based on the risk profile desired."
Yacov Arnopolin, Portfolio Manager

Emerging markets include commodity importers and exporters

Although some countries are heavily dependent on oil exports, across the wider emerging market universe – and specifically in South East Asia, Eastern Europe and the Caribbean – many countries are net importers rather than exporters. Even Mexico, commonly perceived as a significant exporter, imports oil and exports refined products.

Hence low commodity prices are not necessarily bad for emerging markets. They can come as a relief for importing countries as they improve their current account balance. On the other hand, very high commodity prices are not necessarily good as they may encourage a lack of fiscal discipline among exporter nations. This divergence between importers and exporters can be positive for active investors as it enables them to differentiate within the universe.

"We think oil prices will be range bound in the near-term. This can be a sweet spot for emerging markets."
Yacov Arnopolin, Portfolio Manager

Emerging market crises have become more contained

In the early days of emerging markets investing, trouble in one country could quickly spill over to another. Events such as the Tequila crisis in 1994, the Asian crisis in 1997, and Russia's default in 1998, all contributed to the perception that emerging markets were prone to "contagion risk".

However, growing investor sophistication has led these types of events to stay more isolated. Political upheaval in the Ukraine, which started in late 2013 and led to Russia’s annexation of Crimea and the downgrade of its debt by rating agencies, prompted many investors to pull out of Russia. However, rather than leave emerging markets entirely, fixed income investors rotated into the bonds of other commodity producers like Kazakhstan.

Of all countries, China has the potential to generate the widest reverberations. However, the impact on EM debt investors could be mitigated by two factors. First, the main emerging market debt indices do not include Yuan-denominated Chinese bonds, and second, a slowdown in China could trigger looser monetary policy, which would be positive for fixed income investments.

"EM has evolved a lot. Country specific events are more contained and markets less susceptible to panic."
Yacov Arnopolin, Portfolio Manager