Jorge O. Mariscal is responsible for developing the UBS Wealth Management investment views on emerging markets across different assets and geographical regions. Prior to joining UBS, he was a Partner and Chief Investment Strategist at The Rohatyn Group, a multibillion dollar New York-based asset manager exclusively focused on the global emerging markets. He earned a Bachelor of Arts in Economics from UAM University, Mexico City and a PhD in Development Economics and International Finance from New York University.
As the world settles into “a new
normal” environment of very low
interest rates and uncertain growth,
we believe we may be at the onset
of a multi-year period of currency
realignment in favor of currencies
from countries with stronger balance
sheets, more leeway in monetary
policy matters, and better growth
fundamentals. Emerging market (EM)
currencies comprise most of this
universe, yet they are underowned
and misunderstood as an asset
class. This presents investors with an
opportunity to take full advantage of
what we see as a long-term trend.
An impressive track record, yet underappreciated
EM currencies have provided solid risk-adjusted returns. From July 2002 to July 2012, the average annual total return of the JP Morgan Index of 24 EM currencies was around 8%. This was achieved with less than half the volatility of the S&P 500 Index. Furthermore, EM currencies can improve investors’ portfolios as they offer more diversification benefits than stocks or bonds—currencies are not only a financial instrument, but also an instrument of international trade and monetary policy.
It’s more about total return
Looking at the sources of EM currency returns, it is not just about their nominal or “spot” values. It is more about total returns, that is, the spot value plus the interest earned from holding these currencies in the form of short-term interest rates of each country—otherwise known as the “carry”. When including interest (“carry”), an EM currency basket has the potential to contribute positively to the longer-term returns of a well-diversified portfolio.
Funding your exposure via diversified DM currencies
Since currencies always trade against other currencies, the spot appreciation potential is influenced by the funding currencies. We believe there is a significant medium-term case to fund EM currency exposure via a diversified basket of developed market (DM) currencies. The US dollar, the euro and the Japanese yen are all attractive options given the trend towards debt monetization in the developed world as a way to partially address their sovereign debt overhang. Exposure to EM currencies can thus be a source of protection for an eventual scenario of DM inflation and currency debasing.
Not all EM currency investments are created equal
Not all EM currencies will outperform, and not all DM currencies will weaken. For investors, the reference currency matters and influences how much they should ideally invest in emerging markets, and which currencies provide optimal diversification.
Investors in EM currencies should also be willing to tolerate setbacks and periods of substantial weakness. For investors looking to strategically increase their exposure, this weakness can also present good entry points.