Value option or bear trap—these are the paths presented when it comes to emerging markets (EM), which could face significant risks ahead, making the latter option plausible despite the enticing low-priced EM assets.
“On Wall Street it is said that when the winds are strong, even turkeys can fly,” Desmond Lachman wrote in The Hill. “By this, it is meant that when money is very easy, even un-creditworthy borrowers will find it easy to raise money to finance their expansion. But when the winds die down and money becomes tight, those borrowers find themselves crashing down to earth. They also often find themselves unable to repay their creditors without restructuring their debts.”
“Unfortunately, today this adage would seem to apply to all too many emerging market economies,” Hill added. “Over the past decade, when the world’s central banks’ ultra-easy monetary policies flooded the markets with liquidity, the emerging market economies were able to borrow freely. They could do so despite a significant weakening in their underlying economic fundamentals in general and their weak public finances in particular.”
Lachman went on to discuss an issue that could affect all global markets, but EM in particular. That’s the growing amount of debt and the high risk of default in a post-coronavirus market.
“The scale of emerging market economies’ borrowing that ensued was without precedent. According to the Institute for International Finance, over the past ten years, emerging market debt approximately doubled to around $72 trillion or almost 190 percent of GDP,” Lachman wrote. “A further indication of how important emerging market debt has become is the fact that around $6 trillion in emerging market syndicated loans and bonds, or more than a quarter of the global total of such loans and bonds, will mature this year.”
An EM ETF with Currency Hedging Baked In
With the risk in EM assets, investors will want to employ some method of hedging, and while investors can utilize a plethora of currency hedging techniques, one way to do so without overcomplicating the process is via currency-hedged exchange-traded funds (ETFs). One fund is that hedges against EM countries like Brazil is the Xtrackers MSCI Emerging Markets Hedged Equity ETF (DBEM).
DBEM seeks investment results that correspond generally to the performance of the MSCI EM US Dollar Hedged Index. The fund, using a “passive” or indexing investment approach, seeks investment results that correspond generally to the performance, before fees and expenses, of the underlying index, which is designed to track emerging market performance while mitigating exposure to fluctuations between the value of the U.S. dollar and the currencies of the countries included in the underlying index. It will invest at least 80% of its total assets in component securities of the underlying index.
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