Currency Movements a Risk to EM Performance
Macroeconomic developments have begun to cause emerging market currencies to diverge. For non-local investment vehicles—such as U.S.-domiciled emerging markets mutual funds—such shifts represent a risk to net performance as increasing dispersions among currencies may hurt USD returns for associated equities. Figure 1 illustrates the growing divergence between the MSCI EM Index (yellow line) and the JP Morgan EM Currency Index (white line), indicating the increasing volatility of local EM currencies relative to equities.
Figure 1: MSCI EM Index versus JP Morgan EM Currency Index
Given our active management approach and our synthesis of micro and macro research, we have accordingly pared back on selective areas where fundamentals may be jeopardized by sustained currency pressures. Some examples of tactical adjustments include decreases to positions in small markets such as Thailand and Indonesia, as well as to some defensively positioned companies where multiples have rerated ahead of fundamentals as a result of the low-rate, low-volatility environment.
As we ponder “where to go next,” we are cognizant of investor expectations for the emerging markets (Figure 2). Sentiment toward the asset class continues to linger at multi-year lows, reflecting pessimistic expectations among institutional investors. Accordingly, risk/reward profiles for certain companies, countries and sectors continue to shift. Through timely fundamental analysis we intend to adapt to the continually changing landscape. To learn more about the positioning within the Driehaus emerging markets strategies, download our May fact sheets (links below).
Figure 2: Net % of Global Investors Overweight to EM Equities at Lowest Level since March 2011