How Currencies Take a Large Bite out of Emerging Market Investments

By Dr. Sonu Varghese via

Emerging markets (EM) have been all over the news recently thanks to crises in Argentina and Turkey, and EM equities have seen significant drawdowns. Ben Carlson, at Ritholtz Wealth Management, recently wrote an excellent piece about emerging market corrections and bear markets.  He discusses how Emerging Markets are ridiculously volatile, with corrections and bear markets outnumbering those in the US by more than 2-to-1.  This is in the context of yet another bear market in EM equities this year, with the MSCI Emerging Markets Price Index falling 19.8% from its peak in late January.

However, this is in US dollar (USD) terms.  In other words, it is the return seen by an investor who uses dollars to buy a basket of emerging market stocks, with the interim step that the US dollar is first converted to local currency.  Which introduces currency risk.

If you look at the MSCI Emerging Markets Price Index in local currency terms, the maximum peak-to-trough drawdown this year is only -13.9%.  On the year, the index (including dividends) is down -2.5% in local currency, compared to -7.7% in dollar terms (as of August 23rd).

This led us to compare drawdowns in dollar and local currency terms going back in history.  We use Ben Carlson’s piece as a reference for identifying corrections and bear markets since 1994 (the exact periods and numbers may differ slightly because we use monthly data instead of daily data).  So the table below is more or less a replication of his table, but with data in local currency included.

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