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UBS research focus: Emerging market currencies: The case for an underappreciated asset class

Zurich/Basel | | Media Releases Switzerland

 

As an asset class, emerging market currencies have offered a profitable and comparatively secure investment in the emerging markets for more than a decade. This is especially noteworthy since investors seeking to profit from emerging market growth do not immediately think about currencies as an asset class, although these currencies could make a substantial contribution to future returns in a diversified portfolio. In the recently published UBS study "Emerging market currencies: The case for an underappreciated asset class," analysts from UBS CIO Wealth Management Research examine the asset class's characteristics and qualities. These include above-average interest rates and long-term upside potential versus the major global currencies.


Zurich/Basel, 3 October 2012 – It has now been five years since the outbreak of the financial crisis. Central banks in the major financial centers have since kept their interest rates at exceptionally low levels – and look set to keep them there for the foreseeable future. As the world gradually settles to a new normal, we are most likely at the beginning of a phase of currency adjustments that will last several years. Currencies of countries with solid government finances, more monetary policy flexibility, better growth prospects and attractive interest rates stand to benefit from this development. Emerging market currencies make up the lion's share of this universe. For that reason, we expect these currencies to appreciate against the major global currencies – the US dollar, the euro, the pound sterling – in the years to come.Emerging market currencies are an underappreciated asset class from at least two perspectives. Investors wishing to benefit from the emerging market growth story do not immediately think of currencies. However, a well-diversified basket of emerging market currencies has yielded an average annual return of 7.8 percent over the past ten years, while being subjected to a level of volatility two thirds lower than that of emerging market equities. This has made emerging market currencies a profitable and more secure investment than emerging market equities for more than ten years.

Emerging market currencies are an underappreciated asset class from at least two perspectives. Investors wishing to benefit from the emerging market growth story do not immediately think of currencies. However, a well-diversified basket of emerging market currencies has yielded an average annual return of 7.8 percent over the past ten years, while being subjected to a level of volatility two thirds lower than that of emerging market equities. This has made emerging market currencies a profitable and more secure investment than emerging market equities for more than ten years.

Emerging market currencies are also underappreciated in a more literal sense. As an asset class, they are positioned to appreciate against the currencies of the industrialized nations over the medium to long term. The paradigm shift in economic policy instigated in the late 1990s, the focus of which was to improve fiscal and monetary policy, rein in government debt and build up a buffer of foreign currency reserves, has significantly improved the stability of the economies and financial markets of emerging countries. This has helped them put their painful past of irregular growth, high inflation and strong, abrupt depreciations behind them.

Emerging market currencies can thus play a key role in optimizing investors' portfolios. But not all emerging market currencies will appreciate against major currencies, and not all currencies of industrialized nations are weak. The key factor for investors, therefore, is the reference currency. The characteristics of the home currency have an influence on how much an investor should ideally invest in the emerging economies and which currencies provide optimum diversification. What is more, the uptrend is almost sure to be interrupted by phases of weakness. Investors should therefore brace themselves for a certain rise in the overall volatility of their portfolios and only invest money that they can leave invested for an extended period. This will protect them against having to sell at a loss in such phases of weakness. On the other hand, these weak phases could offer good buying opportunities for investors seeking to increase their exposure to emerging market currencies.

UBS AG

Media contact

Dr. Costa Vayenas, UBS CIO WM Research, Head Emerging Markets Research
Tel. +41 44 234 44 43

Dr. Michael Bolliger, UBS CIO WM Research, Head Emerging Market FX and Rates
Tel. +41 44 234 66 34

UBS research focus: www.ubs.com/researchfocus-en

www.ubs.com