Long-term case for emerging markets investments is intact

ANOTHER season, another ordeal for emerging markets. EM performance was stellar in the past two years, with a lofty 37 per cent return in 2017, compared to developed markets' return of 22 per cent, based on the MSCI Emerging Markets and World Indexes, respectively.

Year 2018, however, is challenging thanks to heightened volatility and country-specific issues, not helped by rising trade tensions between the US and China. The latest fund manager survey by BofA Merrill Lynch shows allocations to EM equities fell 9 percentage points to a net 10 per cent underweight in August, the lowest since March 2016 and a massive reversal from the net 43 per cent overweight in April 2018 when EM was the most favoured region among respondents. Fund flows remain positive, albeit significantly slower. IIF's capital flows tracker for August shows net inflows of US$2.2 billion comprising US$7.1 billion into equities and an outflow of US$4.8 billion from EM debt. Between January and August, the total inflows into EM debt and equity came to US$154.8 billion, compared to US$241.1 billion in 2017.

So what has happened this year to cause the downdraft in EM debt and equity? A number of factors are in play. One is the trifecta of US economy, stockmarket and the US dollar whose ongoing collective ascent has taken the shine off EM assets. Of these, the US dollar strength is arguably the biggest dampener on EM assets. EM currencies have tumbled, in particular the Argentine peso, Turkish lira and the Brazilian real. Higher oil prices are another factor, even if a mixed blessing - positive for oil exporters in EMs, and negative for importers. Economic growth is also turning patchy. The IMF in its July update maintained its forecast for global and EM growth at 3.9 and 4.9 per cent, respectively, for 2018. But it noted that the balance of risk is shifting to the downside as tariff hikes by the US and retaliation among trade partners could depress medium-term growth. It also notes that growth prospects among EMs are becoming more uneven.