Tuesday, 23 August 2016

What is an emerging market?

There is some dispute among financial institutions about what exactly constitutes an emerging market, but what most of them seem to agree on is that the sector is likely to deliver the highest growth rates over the long-term. There is no hard and fast definition of an emerging market, but they are understood to include countries that have yet to achieve the standard of living and GDP per capita of the developed world – principally western Europe, North America and Australasia. 

The poorest countries in the world are not necessarily considered emerging markets: frontier markets are at a lower level of economic and political development. In theory, countries should be expected to move up the categories as they grow richer. Which category a country falls into is in the eye of the beholder: different institutions have different definitions. By and large they agree, but this is not always the case.

South Korea is an example of a country that sits on the border between two categories. FTSE considers it to have gained developed world status, while MSCI considers it to be an emerging market. Countries can even be demoted, with Greece seeing its status cut as a developed market by Russell last year, and MSCI and FTSE both considering doing the same.

All the risks associated with emerging markets are magnified in frontier markets, and recent history suggests it is much harder to make money in such funds. The MSCI Frontier Markets index was launched in February 2008 and data shows it has struggled since then compared with the emerging markets index. Many analysts suggest that frontier markets are too specialist for the majority of investors, and are more appropriate for investors with large portfolios who can better absorb losses and who want to diversify their riskier holdings.

Why invest in emerging markets? Emerging markets generally see higher economic growth than the developed world. Most commentators expect this to continue for many years to come. For those who invest in funds, there may be an additional benefit, in that emerging markets are less well-researched than their developed counterparts. There are fewer analysts working on the companies and fewer funds with local knowledge, meaning that it is generally accepted that managers are more likely to outperform the wider market. This means that the best funds in the sector have managed to beat their peers by a large amount.

What are the risks? Along with the higher growth potential associated with emerging markets comes higher risk. Data shows that the volatility of the MSCI Emerging Market index tends to be significantly higher than that of the FTSE All Share. There are a number of reasons for this on a company and fund level. Some funds have a better track record of managing those risks, and it is noticeable that those that sit at the top of the performance tables are run by fund houses known for taking a more cautious approach.

How can you invest in emerging markets?  Emerging markets are now a mainstream asset class, and it is rare to find an investor without an emerging markets fund in their portfolio. There is a large amount of choice: investors can buy a fund that specialises in emerging Asia, China, Latin America, south-east Asia, or even emerging European countries such as Russia and the old Warsaw Pact nations.

For most investors, a general emerging markets fund is likely to be more appropriate, advisers say, as the diversification they supply lessens the currency and political risks that are taken on with emerging markets funds. As always seek professional advice where appropriate.

Wednesday, 3 August 2016

How could Donald Trump impact your portfolio?

How would investors’ portfolios would be affected if ‘The Trump’ was to win the US presidential election in September.

The real estate mogul and media personality, who has funded his own campaign, has struck a chord with many Republican supporters thanks to his rhetoric surrounding immigration, foreign policy and very laissez-faire attitude to government intervention.

Still, though, the bookies are preparing for a Hilary Clinton-led Democrat victory at the polls no matter who leads the Republican Party. Though Trump will no doubt have to moderate if he is to stand for the election in order capture the floating voter, his statements so far (“We will build a wall and they will pay for it”, being one of them) have led many to view his rising popularity as a major headwind for global financial markets. 

It’s our view the upcoming election in the US is what the market should be worried about – not the June referendum on the UK’s future relationship with the EU. Barry Eichengreen – former senior policy advisor to the International Monetary Fund and now professor of economics and political science at University of California, Berkeley – recently gave his thoughts on Trump’s huge rise in popularity and the impact his victory at the election in September would have on markets.

According to Eichengreen, there are four primary reasons behind his surge in the polls – and they are all longstanding issues that have largely been masked by the housing boom prior to the global financial crisis. These are the developing inequality problem since the early 1970s in the US, concerns about the US’s trading partners, immigration and the US’s role in the world. He says that Trumps policies will have a profound effect on the US and therefore global markets.

In terms of financial reform, Trump has said he would repeal the Dodd- Frank Act of 2010 but hasn’t provided an indication of what financial reform, if any, would be used as a substitute. The Dodd–Frank Wall Street Reform and Consumer Protection Act was brought in by president Barack Obama in June 2010 in order to “to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail’, to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes”.

It has been the largest piece of financial regulation since the Great Depression. While the deregulation of the banks in the late 1980s through to the 2000s caused soaring financial markets, any changes to the current system are seen as dangerous by many.

That being said, he also notes how Trump plans to blow up the US’s existing trade agreements – a move that many are worried given the prospect of a trade war in that scenario. As such, if Trump were to win the election, Eichengreen believes the effect would be very negative for financial markets thanks to his right-wing polices and would cause a fall in sentiment among global investors.

“However, the difference for the United States is that things that are bad for financial markets tend to be good for the dollar. The dollar remains the only safe haven currency, so when Lehman Brothers failed the dollar strengthened because people value safety of liquidity,” Eichengreen said. The US treasury market is the most liquid financial market in the world, so we might see that peculiar chain of events again [if Trump became president] – financial markets that crash and a dollar that strengthens to the extent that US exports become less competitive are not a good combination for the US economy.