Amount of Foreign Capital in Emerging Markets is Dwindling

It’s safe to say that since Covid-19 posed a global threat to economies, emerging markets (EM) would be facing an uphill climb. Things aren’t getting any easier for EM as the amount of foreign capital flows for the affected space is dwindling.

“The global coronavirus pandemic threatens to send capital fleeing from emerging economies, as falling exports and a dearth of tourists cause foreign reserves to dry up. Meanwhile, weaker local currencies make servicing external debts harder,” a Nikkei Asian Review article noted. “This confluence of negative factors has financial markets watching closely to see if once fast-growing economies can weather a prolonged downturn.”

During the height of extended bull run prior to the pandemic sell-offs, emerging markets were considered a value play given their low prices. The U.S.-China trade war may have wreaked havoc on EM prices, but a buy-the-dip opportunity presented itself for value investors.

From the start of 2020, it looked like that value play was a good bet until the coronavirus toppled down any expectations of an EM rebound.

“Emerging economies are earning much less foreign currency this year. According to the International Monetary Fund, the average current account deficit of 141 emerging economies, excluding China, is expected to be 2% of gross domestic product,” the article added. “Foreign reserves, which offer a snapshot of a country’s ability to pay its debts, are dropping in emerging economies. About 60% of these reserves are in dollars. In 32 emerging economies, excluding China, foreign reserves fell by $50 billion in April versus the end of last year to $2.8 trillion.”

Detractors of EM assets might underscore the potential for high volatility, particularly during a market downturn. This was definitely apparent during the height of coronavirus fears in March where EM assets plummeted.

As such, one fund to consider for broad-based emerging markets exposure, but with less volatility risk is the FlexShares Emerging Markets Quality Low Volatility Index Fund (QLVE). QLVE seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Northern Trust Emerging Markets Quality Low Volatility IndexSM.

The underlying index is designed to reflect the performance of a selection of companies that, in aggregate, possess lower overall absolute volatility characteristics relative to a broad universe of securities domiciled in emerging market countries. Under normal circumstances, the fund will invest at least 80% of its total assets in the securities of the underlying index and in ADRs and GDRs based on the securities in the underlying index.

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