3. Diversification (albeit with more volatility). Part of the case for EM is based on risk. While EM stocks have become more correlated with those of the developed world, they are still diversifying over the long term. In other words, while EM stocks are volatile, for certain portfolios, emerging markets can potentially help risk-adjusted returns through diversification.
4. Most EM currencies still look inexpensive relative to the dollar, even after this week’s rally in emerging market currencies. If anything, a more accommodative monetary policy and a softer dollar are supportive of emerging markets.
To be sure, there are headwinds facing EM stocks. Amid the volatility we could see ahead as the US budget debate heats up and the recent drawdown in sovereign foreign exchange reserves, EM countries are facing increasing pressure to raise local rates, as evident in Friday’s news out of India. Higher rates would be a headwind to nascent EM growth stabilization. As such, I’m advocating that implementation in the EM space should be largely driven by investor risk tolerance. Investors looking to gain some EM exposure while seeking less volatility may want to consider minimum volatility as well as long-short funds. But the good news is that the Fed’s reluctance to taper does remove a short-term headwind to EM equities, raising their near-term prospects.
Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist.
