Skip to the content

What the end of QE means for your emerging markets fund

06 October 2014

BlackRock’s Gerardo Rodriguez Regordosa reveals where the end of loose monetary policy could hit emerging and frontier markets hardest.

By Daniel Lanyon,

Reporter, FE Trustnet

Investors should be aware that the end of quantitative easing and rising interest rates will provide a tougher environment for emerging markets funds with a higher exposure to frontier markets and commodity producing countries, according to Gerardo Rodriguez Regordosa (pictured), managing director of emerging markets at BlackRock.

ALT_TAG The Federal Reserve and Bank of England have maintained historically low interest rates for more than five years but these are expected to start being lifted, while the Fed is winding up its quantitative easing programme in the next few weeks.

The threat to emerging markets posed by these two events has loomed with the MSCI Emerging Market index down almost 10 per cent and the IMA Emerging Markets sector average down around 8 per cent over the past month.

Both the index and sector had rallied for most of 2014 following several years of fragile performance.

Performance of sector and index in 2014

ALT_TAG

Source: FE Analytics


Rodriguez Regordosa, who is the former undersecretary of finance and credit for the Mexican government, expects to see particular weakness in commodity producing emerging market countries as developed markets and the US in particular normalise monetary policy.

“We have been having a bit of a correction over the past month after a very nice seven months and now that policy normalisation is taking place and the current account deficit of the US has been shrinking, we could see a stronger dollar,” he said.

“That environment is not supportive for commodity prices as a whole so that explains the recent behaviour we have seen with frontier markets underperforming against other equity markets.”

“If you look at past episodes of rising interest rate environments in the US and tighter global financial conditions and how that translates in emerging market countries, financial markets in those economies have actually not done that well.”

“Equities have done better but fixed income and currencies have underperformed.”

While emerging markets have seen choppy performance over the past three years, frontier markets have steadily outperformed.


Most frontier funds are outperforming the vast majority of funds in the IMA Emerging Market sector average in 2013 and 2014 so far.

For example the $2bn Templeton Frontier Markets fund has returned 31.4 per cent over the past three years while the MSCI Frontier Markets index is up 55.67 per cent.

By comparison the MSCI Emerging Markets index has gained just 0.73 per cent and the average emerging market fund has lost 0.46 per cent.

Performance of fund, sector and indices over 3yrs


ALT_TAG

Source: FE Analytics


However, Rodriguez Regordosa says frontier markets’ strength may be unlikely to continue as rates rise.

“When you invest in frontier markets you get very interesting demographics and you get countries that are at an earlier stage in terms of income per capita development and a lot of exposure to natural resources.”

“That explains some of the dynamics of frontier markets recently and their outperformance this year.”

“However, investors need to be mindful of this as the cycle of monetary policy continues, especially as frontier markets do not look as cheap as they did because of the nice run that they have had.”

One reason for the underperformance is the sell-off in emerging markets in the so called ‘taper tantrum’ of May last year after the Fed announced it would slowly reduce its monthly stimulus programme.

Since this period the threat to the asset class has been heightened by another sell-off in January as the taper began.

However, Rodriguez Regordosa is optimistic that there is less chance of a sell-off in emerging markets as rates rise in the near future than in similar stages in the monetary cycle in previous years.

“There is a difference now in the return structure of local interest rates in emerging economies that was not the case before.”

“The construction of the balance sheet especially at the sovereign level is significantly stronger in emerging economies than it was before.”

“Governments have shifted away from funding themselves in hard currencies and have gone into local currency. The structure of public debt has strengthened by relying more on local currencies. It is a very basic thing but actually very powerful.”

“This implies is that the reliance of global financial conditions and dollar-related financial conditions if anything has been reduced. However, that does not imply that if we see higher rates in the US, we will not see higher rates in emerging economies.”


He says he is responding by staying away from the riskier fixed income regions and gaining emerging market equity exposure through developed market companies who have significant exposure to emerging markets.

“On the fixed income side we have tried to stay away from the very idiosyncratic dynamics of the lower rated sovereigns such as Venezuela and Argentina because we don't have an insight into the fluid situations going on there.”

“Flexibility is going to be key and that is precisely the approach we are taking in a multi-asset context but also within individual asset classes. We want to include developed market companies that have predominate exposure to emerging economies.”

“For example BMW and Diageo are actually getting a significant amount of revenue from emerging economies.”
 
ALT_TAG

Editor's Picks

Loading...

Videos from BNY Mellon Investment Management

Loading...

Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.