Seafarer®

Pursuing Lasting Progress in Emerging Markets

Emerging Markets Briefing

Third Quarter 2017

Emerging Markets Briefing

Seafarer addresses key questions about emerging markets investing and how U.S. investors can integrate the asset class into long-term portfolios.

What role can emerging markets play in U.S. investors’ asset allocations?

The emerging market asset class can serve two useful roles in a long-term investor’s portfolio:

  • Emerging markets offer a prospective source of diversified growth within a long-term investor’s portfolio. During much of the last 15 years, the concept of “decoupling” was in vogue for the emerging market asset class, but was overstated and misapplied. However, Seafarer believes that two recent structural changes – reduced reliance on exports and independent monetary policy – might finally allow the markets to “decouple” from the developed world. “Decoupling” is now relevant, for the first time.
  • A high-quality, income-producing portfolio of emerging market securities (dividend-paying stocks and bonds) can act as a useful source of diversification (or hedge) against the U.S. dollar. Seafarer believes that long-term investors should seek exposure to productive assets with meaningful growth potential, and that are capable of generating income in currencies other than the U.S. dollar.

How should long-term investors integrate the emerging markets asset class into their portfolios?

The emerging markets are likely to remain volatile for the foreseeable future. Risk appetite must dominate any consideration of the asset class. Seafarer believes that investors should consider two key factors:

  • Long-term time horizons are essential. Given the volatility of the asset class, due especially to heightened currency risk, Seafarer suggests that investors adopt a minimum investment horizon of five years.
  • Investors should manage U.S. dollar versus non-U.S. dollar exposures in their portfolios. Rather than initially allocating capital among traditional “asset classes” (e.g., domestic stocks, foreign stocks, bonds, real estate), Seafarer believes investors should measure the portion of their assets that are principally denominated in U.S. dollars versus those assets that are not. After matching U.S. dollar assets against U.S. dollar liabilities, a portion of the surplus capital (e.g., 10% to 30%) can be allocated to the emerging markets.

Why has the emerging market asset class performed well during the first half of 2017?

  • Monetary independence: so far, central banks in the emerging markets have acted independently of the U.S. Federal Reserve – most interest rates have been held at stable levels, despite the Fed’s repeated rate increases.
  • Currencies decoupling: in aggregate, emerging market currencies have exhibited stability and modest strength against the U.S. dollar, despite four rate increases by the Fed since December 2015.1
  • Earnings recovery: relaxed monetary conditions and stable currencies have stimulated a recovery in revenue growth and corporate profits, even as global trade remains soft. The consensus expectation for earnings growth has accelerated from 13% at the outset of 2017 to 20% at present.2
  1. Source: MSCI, based on the MSCI Emerging Markets Currency Index.
  2. Source: J.P. Morgan, “Emerging Markets Strategy Dashboard,” June 22, 2017.

Date of first publication: September 12, 2017.

The MSCI Emerging Markets Currency Index tracks the performance of emerging market currencies relative to the U.S. dollar.  The Currency Index measures the total returns of the currencies of countries in the corresponding MSCI equity index (i.e. MSCI Emerging Markets Index). Index code: MXEF0CX0. It is not possible to invest directly in this or any index.

The views and information discussed in this commentary are as of the date of publication, are subject to change, and may not reflect the writer's current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. It should not be assumed that any investment will be profitable or will equal the performance of the portfolios or any securities or any sectors mentioned herein. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Seafarer does not accept any liability for losses either direct or consequential caused by the use of this information.