With the passage of US President Joe Biden’s US$1.9 trillion Covid relief package almost certain, one thing is clear: ultra-low interest rates are likely to remain in the short to medium term, perhaps even in the long term if inflation remains contained.
In such an environment, emerging-market asset classes still offer exposure to high yields and some exposure to growth at a reasonable price.
Looking back the extraordinary events, mostly triggered by Covid-19, that hit the global financial system in 2020, the prospect looks much brighter in 2021, according to asset managers.
“The massive stimulus, weak dollar, cheaper valuation, strong industry recovery, technology cycle restocking, economy reopening with benign inflation, and abating acute political tension between China and US, all indicate that stars are aligning for emerging market multi-asset investment opportunities,” says Jason Yu, regional head of multi-asset products, North Asia, at Schroders.
This rather optimistic assessment for emerging markets is echoed by Alessia Berardi, head of emerging macro and strategy research at Amundi Asset Management, who says: “One of the most important drivers for investing in emerging markets is growth, not only domestic growth at the country level but also global growth reflected in continuous robust external demand either for commodities or for manufacturing products.”
In any case, it is certain that favourable macroeconomic factors are shaping the investment thesis for emerging markets strongly post-pandemic. In addition, emerging markets have also started to enjoy stronger external positions, particularly better current account surplus and higher foreign reserves, even before the pandemic struck.
All these strong fundamentals make emerging markets also better placed to absorb potential volatility in the event that interest rates or yields rise from here sharply, something which Yu says is not likely to happen.
Even the prospects for inflation that can be triggered the massive cash flow into the financial system arising from the US Covid-19 package, in addition to a similar package from the European Union amounting to US$2.2 trillion, are not seen as a serious concern for some asset managers.
“Although we are seeing some pressure on prices from costs (such as commodities, food and shipping rates), the demand side remains subdued; indeed, the great majority of countries have not reached their 2019 growth levels and will take time to do so. Therefore, our inflation outlook is not a source of concern; it should allow the central banks to withdraw their liquidity support very gradually and even more gradually change their monetary policy stance,” Berardi says.
Perhaps the biggest risk facing emerging-market investors is if the on-going vaccine rollout around the world fails and the virus re-emerges massively in another form, a low-probability scenario.
Another risk is a possible taper tantrum, which happened in 2013 when the markets collapsed as a result of the sudden halt to the US Federal Reserve’s quantitative easing programme. This is also considered a low-probability scenario .
Both Amundi and Schroders, however, recommend that portfolio diversification is crucial when it comes to investing in emerging markets because of the heterogenous nature of these markets.
“EM has gone a long way with much healthier financial conditions now than before. And this is exactly why multi-asset income approach can materialize the EM asset opportunity set with very attractive risk-adjusted results as we have achieved,” Yu says.