Increasing Differentiation
In addition to the moves discussed, we remain comfortable with an underweight to South Africa in comparison to the performance benchmark. Over the past several months, we have been somewhat heartened that many of the potentially more vulnerable economies (Brazil, India and Indonesia) have taken proactive steps to stabilize their currencies, reduce their vulnerabilities and lay a foundation for future growth. Consequently, within the broader theme of differentiation among EM issuers, we are seeing an increased variety in those countries once categorized as vulnerable. We believe that investors will continue to look to Asia as well as Latin America over the next several months as ways to access opportunities in emerging markets. Absent a significant catalyst, we believe that the fundamental story in Asian growth and attractive carry in Latin America will attract a greater percentage of assets compared to slowing growth and geopolitical uncertainty in the Eastern Europe.
A Look at ELD’s Position Compared to the J.P. Morgan GBI-EM Global Diversified Index
• Overweight: Brazil, Chile, Colombia, Malaysia, Mexico, Peru, Philippines, Poland, Romania
• Underweight: Hungary, Nigeria, Russia, South Africa, Thailand, Turkey
• Out-of-Index Allocations: China, South Korea, India
Year-to-Date Performance Snapshot
The Market Outlook
After strong performances for most emerging markets in February and March, analysts were concerned that—absent a catalyst or material pickup in EM growth—markets would not be able to sustain their recent rally. We believe that investors have been slowly moving back into emerging markets, as valuations appear cheap on an absolute and a relative basis. This resulted in a strong rally across emerging markets during the last week of March, pushing EM local debt into positive territory one of the only times this year. The rally in EM currencies (after a massive hike by the Turkish central bank on January 28) has also been encouraging.
However, there has been continued uneasiness concerning U.S. rates ticking higher once investors stop focusing on disappointing Q1 data and geopolitical risk. That said, there has been an interesting response from EM currencies since the hawkish tone of Janet Yellen’s first Federal Open Market Committee (FOMC) meeting. With a majority of EM currencies weaker over the last six months, markets were concerned the FOMC meeting could lead to inflationary pressures. However, inflation has been largely contained (notably in Brazil and India), providing strong support for currency and asset performance. More traders are starting to view the negative carry costs of shorting EM currencies as an increasingly difficult hurdle. This hasn’t necessarily translated into robust, sustained inflows back into EM assets, but less selling pressure has dampened headwinds, allowing for markets to rise.
Ultimately, after a rough patch of market volatility and headline risk, our outlook for EM assets remains much more positive than it does for many opportunities in developed markets. While volatility may reappear at any time, we believe that these fluctuations may ultimately lead to opportunity for intermediate and long-term investors.
1Source: J.P. Morgan, as of 3/31/14.
2Source: Bloomberg, as of 3/31/14.
3Source: Bloomberg, as of 3/31/14.
4Source: World Bank data (purchasing power parity terms), 07/13.
5Source: J.P. Morgan.
6Source: J.P. Morgan, 02/14.
7Source: Barclays.
8Source: WisdomTree, Bloomberg as of 3/31/14.
Important Risks Related to this Article
There are risks associated with investing, including possible loss of principal. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Investments in emerging, offshore or frontier markets are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention or political developments. Derivative investments can be volatile, and these investments may be less liquid than other securities, and more sensitive to the effects of varied economic conditions.
Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. In addition, when interest rates fall, income may decline. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. Unlike typical exchange-traded funds, there are no indexes that these Funds attempts to track or replicate.
Thus, the ability of the Funds to achieve their objectives will depend on the effectiveness of the portfolio manager. Due to the investment strategy of certain Funds, they may make higher capital gain distributions than other ETFs. Please see the Funds’ prospectus for specific details regarding the Funds’ risk profile.Investments focused in Europe are increasing the impact of events and developments associated with the region, which can adversely affect performance.
Bradley Krom of WisdomTree Fixed Income & Currency contributed to this piece.