Stefan Keller, head of MAP research & external relations at Lyxor AM, looks at how emerging markets are showing emancipation in terms of both fiscal policy and economic growth…
In recent months, we have registered structural and cyclical motivations to increase exposure to Emerging Markets. Assets under Management of Emerging Market related Hedge funds on the Lyxor Managed Account Platform (MAP) have risen by more than 60% over the last 15 months.
The secular growth story of Emerging Markets has been known to investors for more than a decade given the rise in the labour force, capital accumulation and progress in governance. A new, structural, feature is that Emerging Market economies offer solid public finances in a world of high indebtedness. Clearly, the lessons of the 1997/98 crises have been learned and the recent economic and financial crisis has its roots in the Developed World. According to IMF data, Debt-to-GDP ratios in advanced economies are expected to exceed 100 percent of GDP this year, some 25 percentage points of GDP higher than before the crisis. The fiscal challenges are different in a number of emerging economies, with some important exceptions. The public debt problem in these economies is more localized – as a group, these economies’ public debt ratios are at about 30 to 40 percent of GDP and, given their high growth, are already back on a declining path. Evidence of this is the fact that more than 50% of the constituents of the JP Morgan EMBI index enjoy an Investment Grade ranking, with more upgrades likely to come. Emerging markets show emancipation in terms of fiscal policy and in terms of economic growth.
The cyclical outlook is also favorable to Emerging Markets, at least relatively to Developed Markets. Emerging Markets show emancipation in terms of monetary policy as the tightening process has started for quite a while and Central banks are now ahead of the curve, contrary to those in advanced economies. 21 out of the 28 Central banks that have hiked policy rates since September 2008 are located in emerging markets. These measures go hand in hand with the rise in the value of their currencies: policymakers in Emerging Markets have started to soften the tone recently, suggesting that these countries are likely to avoid a hard landing in the forseeable future.
We have been gathering Hedge fund manager’s views on recent events in the Middle East and in North Africa. Most of them think that there is no direct link between the Federal Reserve’s QE II and the recent unrest. Further, the risk of a double-dip recession due to the rise in the price of oil since the start of the year is rather contained, in their view. However, the managers agree on the idea that Emerging markets are set to become an exporter of inflation going forward rather than an exporter of disinflation. This marks an important change compared to the last two decades.
On the Lyxor MAP, we are able to analyse Emerging Market exposure through many different ways. Beyond beta-exposure, the managers have proven their ability to generate alpha over several years. In addition to Emerging Market specialists, some of them are not genuine Emerging Market Hedge funds but we thought it useful to include Global Resources and Commodity specialists as these markets are likely to be dominated by changes in Emerging Market demand over the next decade. Similarly, some systematic funds on the Lyxor MAP also offer important exposures towards Emerging Markets. Overall, the managers have access to multiple sources of alpha.
Investors should keep in mind that Hedge fund managers with exposure to Emerging Market themes do not solely play the secular market trend. While they tend to perform better during bull markets (by harvesting their exposure to higher beta) they can also make money in downturns, for example with outright shorts and hedges or with exposures on forex or fixed income markets. Additionally, turbulent markets often deliver pricing opportunities that will improve future performance.
Stefan Keller is head of MAP research & external relations at Lyxor AM
