As choppy as developed markets have been recently, investing in emerging markets (EM) still requires a higher risk tolerance. A reminder of this came on Monday after fresh US sanctions provoked a 12.4% fall in the MSCI Russia Index and a 4% decline in the ruble.
While the latest developments serve as a reminder of EM political risks, we remain cautiously optimistic on the outlook for EM assets as a whole. Volatility can best be managed by diversification rather than by shunning these markets altogether.
- Political and economic crises tend to be localized, enabling investors to cushion large moves by holding a geographically diverse range of EM assets. Russia accounts for just 3.6% of EM stocks, and the MSCI EM Index actually ended 0.1% higher on Monday. Large daily swings in individual EM currencies are not unusual. Over the past five years there have been intraday moves of more than 4% on 17 occasions in the ruble, three instances for the Brazilian real and once for the Turkish lira.
- EM currencies still offer an attractive yield advantage that can help compensate for volatility and depreciation. Our preferred basket includes the Brazilian real, Indonesian rupee, Turkish lira and Russian ruble, and commands a 7.6% carry over a selection of low-yielding developed market currencies.
- EM nations enjoy a growth advantage. Forecasts by the IMF have EM economies growing 5.3% this year – 1.4 percentage points more than developed economies.
So while we will carefully monitor risks, we do not believe that localized political crises undermine the broader case for investing in EM in the context of a well-diversified portfolio. For our latest research on Russia, click here.
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