Lower structural risk in emerging markets
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Alan Dorsey is head of investment strategy and risk at Neuberger Berman, a US-based investment manager that overseas a range of asset classes including global and emerging market equities, bonds, and alternatives such as hedge funds and private equity.
As we start 2013, it is becoming possible that the historical pattern for emerging markets is entering a new phase.
Historically, emerging markets have been highly vulnerable to cyclical issues that tend to create economic highs and lows not necessarily correlated to structural stability or financial realities, but this is now starting to change.
There are a number of reasons for this but the result is that there are now more grounds to think this time is different and that emerging markets are migrating to become more traditional, core asset classes.
This represents a one-time transformation of emerging market equities and debt that could provide a unique opportunity for investors, who generally speaking are underweight emerging market asset classes.
The basic strength of many countries in Asia, Latin America and Eastern Europe has rarely been so secularly robust as it is now, particularly in comparison to many developed countries.
In my view, the final "hurdle" to becoming a permanent part of investor portfolios would be for emerging market economies to put in place more consistent governance practices and, in those countries where it is still a problem, reduce fraud and corruption.
There are several key factors driving the shift from cyclical to structural macroeconomics in emerging markets, including: GDP growth; foreign exchange reserve accumulation; current account surpluses; a growing middle class; robust fiscal and monetary policies; and the stability of local institutions such as sovereign wealth funds and pension funds that are investing in projects in their home regions such as infrastructure.
The main implication of these drivers is that there is a structural reduction of risk in emerging market economies, not least through emerging market debt being upgraded to investment-grade.
While risk hasn't been eliminated entirely, we are seeing a situation where the risk levels of emerging markets are, in many cases, lower than they have been in the past, and potentially lower than those of many developed markets.
For example, the growth in exports in emerging economies has allowed them to substantially increase their currency reserves at a much faster rate than developed countries.
This gives emerging economies more scope to support domestic currencies and avoid currency dislocation in the event of crisis, an issue that emerging markets have been vulnerable to in the past.