Lower structural risk in emerging markets

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Emerging market economies are becoming more structurally sound, creating new opportunities for investors, says Alan Dorsey, head of investment strategy and risk at Neuberger Berman.

“Historically emerging markets have been highly vulnerable to cyclical issues that tend to create economic highs and lows, not necessarily correlated to structural stability or financial realities, but this is now starting to change.”

Dorsey said this represents a one-time transformation that could provide a unique opportunity for investors.

“The basic strength of many countries in Asia, Latin America and Eastern Europe has rarely been so secularly robust as it is now, particularly in comparison to many developed countries.”

He said emerging market economies need to put consistent governance practices in place and, in some countries, reduce fraud and corruption before they can become a permanent part of investor portfolios.

There are several key factors driving the shift from cyclical to structural macroeconomics in emerging markets, including: GDP growth; foreign exchange reserve accumulation; current account surpluses; a growing middle class; robust fiscal and monetary policies; and the stability of local institutions such as sovereign wealth funds and pension funds that are investing in projects in their home regions such as infrastructure.

These drivers reduce the risk in emerging market economies, especially through market debt being upgraded to investment grade.

“While risk hasn’t been eliminated entirely, we are seeing a situation where the risk levels of emerging markets are, in many cases, lower than they have been in the past, and potentially lower than those of many developed markets,” said Dorsey.

“For example, the growth in exports in emerging economies has allowed them to substantially increase their currency reserves at a much faster rate than developed countries.

“This gives emerging economies more scope to support domestic currencies and avoid currency dislocation in the event of crisis, an issue that emerging markets have been vulnerable to in the past.”

The annual household income in China, India and Indonesia is also predicted to increase over the next ten years, as it has the past decade.

The number of households in China with an income between $5,000 and $15,000 has grown from less than 20 million to almost 125 million.

“Furthermore, trade between emerging economies has grown and diversified, reducing their reliance on the Western world and potential exposure to the economic malaise affecting Europe and the US,” said Dorsey.

“Investors still need to weigh the risk and return carefully but, particularly when compared to the developed world, emerging markets are an increasingly attractive investment option and investors who take advantage of this now are well-placed to benefit from the ongoing growth and strength of the market.”

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