The risk in emerging markets is ignoring them

Investing in emerging markets is inherently risky, but foregoing the opportunity they present could be even riskier, especially at a time when growth in the developed world has been falling, floundering and flat-lining.

Some of the brightest in the world of finance made a compelling case for investing in emerging markets at the CFA Institute Conference in Boston, Mass.

Titled ‘Fixed-Income Management 2011-The Search for Safety and Value’ the conference provides a venue for debate and discovery in navigating today’s markets where uncertainty is the only constant.

The 2008 financial crisis defied every norm and bucked all established paradigms of market behaviour. It changed the world as we know it, said Roberto Rigobon, Society of Sloan fellow professor of applied economics at MIT.

“Capital flow generally goes from countries that are unaffected to the countries that are affected,” he said. “But the 2008 crisis was very different in that there wasn’t a country that wasn’t affected, therefore the recovery from it has been very disorganized.”

It created a two-paced world where some countries recovered very quickly—mainly emerging markets like China and Brazil. “In fact, in Brazil the crisis only lasted for two months. That was a hiccup of a crisis; Denmarrk had only a week of crisis.”

Conversely, there is another set of countries—the UK and the U.S., for instance—that have actually recovered, but at an extremely slow pace, he said adding that at least “on paper, the GDP [of these countries] has recovered.”

This uneven recovery around the world has implications. “I call them global inconsistencies; there are countries that have started to increase the interest rates while there are others that are still torturing the economy, trying to find a confession in any sector,” said Rigobon.

He summarily dismisses the idea of safe havens. “There are no safe havens as no country has been unaffected by the crisis; capital is searching for any tiny return,” he said. “Instead of capital flowing from high interest rate countries to the low interest rate countries in search of investment opportunities, they are going to countries that are booming.”

This unevenness, he said, puts pressure on the global financial system. “Global economy is like a set of big pipes and policies are gates that allow flows to go faster or slower through those pipes,” said Rigobon. “Some countries are trying to flood those gates, while others are trying to do the opposite. This creates pressure in the system.”

And it’s the result of this disparity in the global economy that led to the decoupling of emerging economies. Emerging markets are offering growth and clients should be investing there, says Daniel Fuss, vice-chairman, Loomis, Sayles & Co. “I think there are enormous opportunities there, [but] they come with unusual amount of risk which is sometimes over-discounted and sometimes under-discounted.”

Like it or not, there is no escaping the fact that investors can’t embrace the opportunity without embracing the risk, says Vinay Pande, chief investment advisor, global markets research, Deutsche Bank.

“The world tomorrow is a lower real growth world, [with that growth coming] most likely from the emerging markets source,” said Pande. “In the longest duration, the highest real yielding assets on the planet you could possibly find [will] ideally be denominated in emerging markets foreign exchange.”

He advises investors to “go for the source of what’s going to produce forex appreciation in emerging markets, especially real appreciation which is increasingly going to be commodities over time.”

In a historic context, he said emerging markets are trying to recover from the huge ditch they dug for themselves over the last 300 years, collectively sliding from between 50% and 60% of global GDP, to barely 5%. “Recovering from there is surely something that represents opportunity.”

The emerging world’s share of the overall world GDP is now greater than that of the developed world. Inevitably, say experts, investment portfolios will begin to reflect that reality.