Emerging markets have quickly become one of the only pockets left for investors to find yield. But how long can these growing economies continue to prop up the retirement funds of the western world?
According to BlackRock’s head of Australia fixed income Craig Vardy, the answer lies in the US dollar.
“If the US dollar starts rising then EM gets crushed,” he said. “You’ve got to pay attention to what the dollar is doing. If you want yield then you obviously buy non-hard currency. A weaker US dollar helps EM. You have to be very selective with countries. Often active EM is the better way to go. You want to avoid an Argentina situation.”
Emerging market debt can be an attractive play for investors scouring the globe for yield. But it also carries risks. This year’s Argentina trade was just too good for fund managers to pass up. All hell broke loose when Argentina’s left-wing politician Alberto Fernandez defeated the incumbent president Mauricio Macri in a primary election on the weekend of 11 August. The win by Mr Fernandez triggered major volatility and panic among fund managers with sizeable positions in Argentinian assets after its currency plummeted, share market crashed and the 100-year bond price fell off a cliff. Needless to say, investors lost billions.
Two days after the election result, CNBC reported that Franklin Templeton fixed-income manager Michael Hasenstab lost close to US$1.8 billion ($2.7 billion) in one day.
Despite these risks, EM has been one of the biggest stories of 2019 and many global investment houses are overweight EM equities and fixed-income moving into 2020.
BlackRock managing director and chief investment strategist of Asia Pacific Ben Powell said the loose monetary policy conditions and the change in Fed policy over the last 12 months are a meaningful driver of EM growth.
“The idea that we have a relatively calmer period of time in the US-China trade tensions is obviously very important. However, looking forward we believe moving forward the tensions are structural and persistent,” he said.
“But if the tensions have subsided for now, some of those emerging markets should benefit.
“The great challenge for our time is investing for income. Globally, with around $12 trillion in negative yielding debt, you need to be a bit more creative when it comes to income needs.”
Mr Powell pointed to Indonesia as potential allocation in 2020.
When it comes to China, while its economy is growing at a slower rate, like all emerging markets it comes down to the US dollar.
“If you go back 15 years to 2004, China’s GDP was a bit less than $2 trillion. So if China grew 20 per cent in 2004, that’s $400 billion of incremental GDP. If you roll forward to now, China’s GDP is around $14 trillion. If you allow me to use CPI and real GDP you get a growth figure of about 10 per cent. So 10 per cent on that is $1.4 trillion. While it is true that 10 per cent is a lower percentage figure than 20 per cent, it is also true that that $1.4 trillion is a meaningfully bigger number than $400 billion,” he said.