Risk aversion halts surge in EMs
Most emerging markets see redemptions by global funds as geopolitical tensions flare up
Risk aversion among global fund managers due to geopolitical tensions has applied brakes on the stellar run seen in the emerging markets (EMs) this year. Foreign funds pulled out over $4 billion from EMs, weighing on the performance of key markets such as India and South Korea. Both the markets shed over two per cent in dollar terms during the month. Other EMs such as Indonesia and Mexico ended the month little changed. The MSCI EM Index saw a slight uptick because of gains in the China market, an index heavyweight which largely depends on local flows.
The risk-off sentiment has been created by tensions over North Korea and US relations, with the former escalating threats of a nuclear attack.
“August has been a bad month for EMs. FIIs (foreign institutional investors) took money off the table from EMs as simmering tensions between North Korea and the US hurt investors’ risk appetite. On the other hand, the valuations of several EMs also looked expensive. Further, the growth in earnings and other economic fronts has not been great across EMs. All these factors led to the sell-off,” said Andrew Holland, chief executive officer, Avendus Capital.
In the near term, analysts expect moderation in the EM performance as global funds were seen moving their bets to safe-haven assets such as developed world bonds and the Swiss franc.
However, on a long-term basis, market events see EMs structurally better-placed to do well.
“The performance of US equities has been very good and now people are starting to think it’s time to diversify and they have been underweight on emerging markets. For the last many years, the world’s engine of economic growth hasn’t been in developed markets, it’s been in emerging markets,” said Mark Mobius, executive chairman, Templeton Emerging Markets Group.
On a year-to-date basis, the MSCI EM Index, a gauge for the performance of 24 developing nations, has outperformed the MSCI World, an index dominated by the developed markets.
FIIs have been a key driving factor for the EMs this year. About $60 billion has flown into most major EMs this year, fuelling gains in their stock prices and currency.
According to experts, one of the key headwinds for the EMs going forward could be disappointing growth numbers, including corporate earnings and gross domestic product (GDP).
They say the strong portfolio flows into EMs in the past few months was in anticipation of better growth. As demand in the US gradually picks up, export-driven economies such as South Korea, Taiwan and Brazil are expected to do well.
On the other hand, India is expected to benefit from stability in the broader economy, along with the liquidity rush in the markets. The steady demand for equities from domestic investors is also providing buoyancy to Indian shares.
Among the EM pack, South Korea and China are the biggest recipients of foreign flows because of their high weightage in the index.
Market players expect India’s weightage to improve, which would help attract greater share of flows. Also, the North Korea episode could negatively impact its southern neighbour, which could prove advantageous to India, experts say.