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Ashmore: Brexit shows markets totally underestimate DM risks

The spill-over of post-Brexit market pandemonium was fairly minimal in EMs with the exception of some Eastern European countries like Poland and Hungary. But above all, recent market activity shows investors generally underestimate – and thus aren’t compensated for taking – risks in developed markets, according to a recent note from Ashmore Investment Management.

Jun 28, 2016 // 8:47AM

Jan Dehn, firm’s Head of Research, said that despite the rise of nationalism and populism (particularly Europe, the UK and the US), exhausted monetary policy, and lower forecast growth in developed markets, investors disproportionately treat DM assets as friction-free and generally less risky.

DM assets, particularly US Treasuries, German Bunds, Japanese Government Bonds, and (until very recently) UK Gilts are typically considered safe havens for investors’ cash. But with negative rates sinking in across many DMs and volatility on the rise in the short and longer term, it is clear some investors are beginning to question whether the risk-reward tradeoff is worth it.

“It is time to ditch the fiction of risk-free developed markets,” he said, adding that investors should seriously consider cutting their exposures to DM assets.

Dehn believes 2016 will see emerging markets outperform their DM counterparts for a variety of reasons: EM technical are solid and positioning isn’t crowded; absolute valuations and yields in EMs are attractive; EM fundamentals including external balances are robust; and EM central banks have more room to manoeuvre than DM counterparts in the event of a shock.

The Brexit vote has only served to highlight the growing role of DM volatility across the asset landscape, something many investors don’t yet fully appreciate, he explained.

“Given that the underlying problems are far from being resolved, it is likely that developed markets will continue to be a source of instability for global markets. Investors really ought to ask themselves if it is appropriate to continue to be heavily invested in such countries. In EM, volatility is generally expected, but in most developed economies risks are sometimes not even perceived, let alone priced. The -11.75% intraday move in GBP on Friday was a 21-standard deviation event. It is time that investors wake up to the fact that developed markets are far from risk free and that investors are simply not paid adequately.”

Dehn said that as an example, between 2000 and the end of May 2016 European investment grade government bonds saw twice the volatility of Euro-denominated EM investment grade government bonds, yet paid investors only half the yield.

“It is also illustrative that Moody’s only moved the UK outlook to negative from stable after the Brexit event and that the ratings agency still has the UK sovereign credit rating at Aa1. This despite the fact that the country’s main political parties are falling apart and that the entire nation is at risk of disintegration as Scotland and Northern Ireland now consider their futures within the union.”

“We strongly recommend that investors face up to these facts and significantly reduce their exposure to developed markets,” he added.

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