Emerging Markets Are Definitely Reemerging, Experts Say

While emerging markets can’t be characterized as less risky than developed markets, the risks must be considered broadly

This year’s rally in emerging stock markets is a true “classic,” and should be an indicator for a better 2017 in that arena, said Edward Kerschner of Columbia Threadneedle.

Speaking at an emerging markets presentation during the Morningstar ETF Conference in Chicago, Darek Wojnar, head of ETFs of Hartford Funds, agreed with Kerschner, stating the “fundamental growth across emerging markets is not just growing faster than developed economies,” but the growth gap between them has stabilized and has possibly even reversed.

Jeremy Schwarz, director of research for WisdomTree Asset Management, said the environment is due in part to the Federal Reserve’s inaction. He explained that “everyone thought they would hike [interest rates] four times, and now it may not until December….”

He also said that “last year everyone was freaking out about China and its currency and how to manage it,” but that has curtailed and China does not seem to be doing as poorly as originally feared.

Moderator Patricia Oey of Morningstar asked about valuations, and what return expectations are on emerging markets.

Schwartz said it depends how one slices up emerging markets, stating those with low volatility are the most expensive.

Wojnar noted that regardless of what one looks at—net income, dividends, etc.—“there are parts of emerging markets that, compared to developing markets, look more favorable, but there is a consensus [emerging markets] should be less expensive than developed.”

Kerschner agreed emerging markets are cheaper than developed markets, but within emerging markets, some are expensive, and, in fact, “they aren’t getting wealthier than the United States,” but the rate at which they are getting wealthier is growing.

Regarding risks in emerging market investing, Wojnar said emerging markets can’t be characterized as lower risk than developed. That said, he added, “Risks are part of this universe and must be considered broadly.”

For example, his firm looks at country stability, government controls on markets, how transparent markets are, or sector risk that is more susceptible to big shifts in commodities prices. “We look at strategic holdings for investors,” he said.

On political risk, Schwartz noted the political landscape in both the United States—with the current election cycle—and in Europe, with Brexit, stating, “Emerging markets’ political risk in some cases looks better.” He added he believes dividends cut across those factors.

Kerschner said some emerging markets are “risky at different times, and are more risky individually than all together.”

Of course, drawbacks exist in emerging market investing, including too much local government control on companies.

Schwartz said his firm avoids liquidity issues in small cap stocks in its emerging market ETF fund [DGS] that has close to $1 billion AUM by being broadly diversified, and by rebalancing once a year.

Despite his colleagues’ support of passive investment, Wojnar said his firm was “comfortable with active managers, especially in selecting individual securities” for emerging markets.
 When asked about hedging currency risk of emerging markets, none of the speakers were enthusiastic. Wojnar said his firm is careful about over allocating exposure, so hedging isn’t factor.

Schwartz said his firm uses dynamic currency funds, which helps with a strong dollar.

Kerschner noted in past 16 years, currency hedging helped in eight and hurt in eight, and cost 20 basis points. Add to that the interest rate differential and  he said it doesn’t compute: “Fundamentals that drive equity markets drive currencies, so being long equities and short currencies is like a dog chasing its tail. If you catch it, it will hurt.”

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