Emerging market exchange traded funds have been gaining momentum in recent months, but the asset category could stumble in the seasonally weak August month.
Over the past three months, the iShares Core MSCI Emerging Markets ETF (NYSEArca: IEMG) increased 20.6% and Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO) advanced 20.5%.
However, a weakening currency could weigh on these developing economies. Looking at historical, in seven of the past 10 years, MSCI’s index of developing-nation currencies has decreased in the month of August, with volatility surging in eight years amid lower liquidity as traders stepped away for the summer hiatus, Bloomberg reports.
Specifically, currencies like South Africa’s rand, Turkey’s lira, Indonesia’s rupiah and India’s rupee have historically experienced their worst volatility during August, based on the average decline over the past five years.
Investec Bank Plc and Societe Generale SA warned that this seasonal trend probably won’t be any different this year, even as the world fights off the coronavirus pandemic.
What is different, though, is that implied volatility for those at-risk EM currencies is currently at the lowest since at least March, which may reflect complacency among investors whom are underestimating the risk of large price swings ahead.
“Markets are complacent about risk at present,” Julian Rimmer, a trader at Investec in London, told Bloomberg. “This is largely a function of hugely accommodative central-banking policies globally, which is subduing volatility.”
Rimmer warned that investors will take time off for summer, which will lead to a usual dip in liquidity over August that typically exaggerates market moves. Potential risks ahead, such as rising tension between the U.S. and China to worsening economic data and renewed virus outbreaks around the world, could trigger wide market oscillations in a less liquid market.
“Emerging-market currencies are always more vulnerable in August because volumes are understandably lower and therefore the illiquidity can exaggerate volatility,” Rimmer added. “Moreover, governments are invariably in a lesser state of preparedness for emergencies, again because so many people are away.”
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