Time to shift your emerging markets approach?

Why changing perceptions to emerging markets must start with a change in the way investors view risk

Recent macro events like Brexit and the build up to the U.S. election have highlighted the importance of embracing non-traditional asset classes, such as emerging markets. In the last few months, developed countries have been experiencing a level of political risk not normally associated with mature economies.

Christine Tan, Chief Investment Officer, Excel Investment Counsel Inc., believes that recent events have played an important role in reminding investors about the importance of differentiating between perceived and actual risk. “Investors tend to perceive risk based on whether something is familiar and unfamiliar, and have a strong bias towards Canada and other developed countries,” she says. “To me, real risk is what we pay for assets. For example, it’s much riskier to be in negative yielding German bonds than to be in emerging markets fixed income.”

For investors to truly embrace the opportunities available in emerging markets, advisors need to change their own perceptions of certain markets and their risk level. “Many investors are comfortable investing in Europe or Japan but are tentative about emerging markets because they lack experience and consider them to be highly volatile,” Tan says. “That is a historical bias: investors tend to look backwards and expect what has happened in the past to continue, but that is typically false.”

In the past few years, the central banks of many emerging markets have made impressive adjustments to the changing macro environment. Default rates have been minimal since 2013 and the widening of the bond spread in emerging markets turned out to be unnecessary. 2016 in particular has witnessed some significant events that have helped to increase financial and political stability in some typically uncertain regions.

In June, the Indonesian parliament approved an impressive tax amnesty program which will allow Indonesians to repatriate assets from overseas at a one-time tax rate of 2 – 5%. Then, the Indian senate passed the GST reform; Dilma Rousseff was impeached in Brazil and after 50 years of ongoing conflict in Colombia, the government signed a ceasefire with Fuerzas Armadas Revolucionarias de Colombia—Ejército del Pueblo (the Revolutionary Armed Forces of Colombia—People's Army or the FARC).

Also, Argentina elected its first ever pro-business president, who has negotiated the settlement of the country’s outstanding debt and issued the first sovereign bond in ten years. “Developed economies are experimenting with monetary policy but it’s not having much impact, but on the emerging markets side there are some amazing reforms that have been happening quietly,” Tan says. “Central banks and governments in emerging markets have become much more accountable and Canadian investors who are still focusing on the perceived risk based on what they recall of emerging markets from the past are missing out.”

 “For advisors, the best way to go is diversified, and emerging markets should definitely be a part of the allocation conversation.”