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Despite a positive outlook, investors to become increasingly picky on EM assets

Although the strong performance of emerging markets looks set to continue, the rally has slowed. Investors are now taking a longer view and are beginning to become much more careful about which investment opportunities they pick.

May 12, 2016 // 6:34PM

The low returns on offer in developed markets could increase the interest in emerging markets. Developing economies could begin to see large interest from abroad from 2017 onwards.

One factor affecting their popularity is that emerging markets in general now have better fundamentals than in previous years, which reduces the risk of defaults.

The main driver behind the growth of emerging markets have been low interest rates in the US and the quantitative easing policies of central banks in developed markets. So far this year, the Bloomberg USD Emerging Market Sovereign Bond Index has risen 7.2%.

A weaker dollar has also had a significant role to play in the recent emerging market upturn. In the previous 4 years the US dollar has been up against emerging market currencies by 10% each year; however, it is currently down against emerging market currencies by 3% year to date.

Despite a weaker dollar and the fact that traders believe the US will not increase interest rates until February next year, the emerging market rally is showing signs of easing.

“The emerging market rally has stalled,” said Edgardo Sternberg, Portfolio Manager at Loomis, Sayles and Company.

Asset management firm BlackRock has said that it is cutting down on its emerging market exposure, citing difficulties in finding good deals. Slowing growth has prompted BlackRock to be more cautious around emerging markets, as many developing economies rely on exports to China for economic growth.

Sternberg did however note that regardless of another fall, emerging market debt should remain relatively stable (both local or hard currency), even if there are fluctuations up until the end of the year.

He added that emerging market currencies were also likely to fluctuate, but that they would inevitably stabilise

 “Weaker Chinese growth combined with a US rate rise would spell bad news for the performance of emerging markets,” Sternberg stated.

The asset manager does see potential in short term Argentine debt, but is wary of longer debt, where speculation has made pricing unfavourable.

Latin America is a region where debt is performing relatively well, as opposed to Asia, where concerns over China weigh on investors’ concerns.

Short duration exposure to emerging market debt is also likely to provide strong growth opportunities as it, to some extent, negates any impact of a US interest rate hike.

Pimco last month also cut its holdings of emerging market debt to its lowest level in almost 2 years. The company cited concerns over the likelihood of the US Federal Reserve to raise interest rates. It is concerned about bonds that have benefitted from yield hunting investors, but the company still sees the value of emerging market debt in the long term.

Sternberg noted that emerging markets would suffer if the US Federal Reserve was to implement two interest rate hikes, but that this was unlikely. The company is much more cautious about emerging markets in the short term, and has reduced its exposure in the more volatile areas of the emerging market world.

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