developed markets—at current growth rates, emerging markets are likely to constitute more than half of the world’s GDP in only 10 to 15 years’ time. As emerging markets join the global economy, we believe we will see them move their economies up the added-value chain from reliance on agriculture—such as is seen in frontier markets—to manufacturing in middle-tier emerging markets, and then on to services, such as seen in more developed markets.
Supporting this fundamental dynamic is a number of key accelerator
themes. Included in these are the positive economic and social reforms adopted by emerging markets over the past decade; the favourable demographics of most emerging markets, where younger, cheaper labour forces can be competitive compared to the older populations of developed markets; the commodities story, where emerging markets are the largest owners of depleting stores of raw materials in a global economy that is ever resource-hungry; and the growing sophistication of emerging financial markets. These themes complement the already strong fundamental backdrop in which emerging economies are moving more and more in line with developed economies. This convergence is likely to generate attractive capital gains for both local bonds and currencies.
Emerging markets account for an increasingly large proportion of
total global GDP and, as they increase in significance in the global arena, asset allocations are likely to change to reflect this. Furthermore, because US dollar weakness appears to be a requirement for addressing global imbalances, emerging market currencies are likely to be beneficiaries of such a move. We believe global investors who are now starting to recognise the attractive risk-return characteristics of the asset class are likely to allocate much more significant sums.
There are risks associated with investing in EMD. Similar to any
emerging markets investment, the asset class may be affected as a consequence of a move towards a risk-averse environment. This may affect both bonds and currencies, causing the yield compression seen over recent years to reverse. However, while investment risks can be significant in an asset class like this, we believe that attractive returns are likely to be delivered against continued comparatively low volatility. The diversity of the asset class, and the high quality of the issuers underpinned by the fundamentals described above, underpin this belief.
Where does an allocation to EMD fit within an insurance portfolio?
For investors considering their allocation, finding a suitable EMD solution may take into account a number of factors including the investor’s specific requirements, risk profile, domicile and regulatory parameters. To summarise the main ways of accessing EMD as an asset class, solutions include local currency denominated or hard denominated sovereign debt; on the other hand, a blended approach where local and hard debt is combined in one investment strategy may better suit an investor’s requirements. Investors may also consider a pure EM currency approach or explore emerging markets corporate debt, a fast-growing area of the asset class. At the same time, an investor’s risk tolerance parameters or investment restrictions might require that only higher rated local EMD markets, such as investment grade-only markets, are part of the investable universe.
“THE GROWTH OF INSTITUTIONAL INVESTMENT IN EMERGING MARKETS HAS PRODUCED A STEADY SOURCE OF LOCAL DEMAND AND REDUCED DEPENDENCE ON VOLATILE, EXTERNAL INVESTMENT FLOWS.”
In the context of an overall fixed income portfolio, an allocation to EMD may
be beneficial for investors looking to diversify away from developed market currencies and developed market spread products, particularly if concerns around developed market holdings are increasing given the potential for further ratings downgrades in these markets. Therefore an allocation to EMD may assist in diversifying the risk of an overall global fixed income portfolio.
EMD can act as an effective diversifier within the growth portion of an insurance fund’s portfolio, rather than the liabilities portion of a portfolio, in much the same way as allocations to alternative asset classes such as high-yield debt or infrastructure might be considered. Furthermore, as a result of Bermuda’s decision to opt for Solvency II equivalence, captive insurance funds which are restricted to investment in higher credit quality as part of their investment guidelines can invest solely in investment-grade rated local EMD. An actively managed approach will seek to identify the best opportunities across the investment universe at any given time, offering excellent opportunities for outperformance due to the large disparity of returns among countries.
Investec Asset Management, founded 21 years ago in an emerging market—South Africa—now manages $99.4 billion for its global client base. Our emerging markets perspective is leveraged across all our investment capabilities, with more than half our total assets under management invested across emerging markets. We have more than 75 investment professionals covering more than 60 emerging countries across our equity and fixed income teams, and a diverse platform covering specialist and core strategies. In the area of EMD our dedicated specialist investment team covers local, hard and corporate EMD strategies. The result is a comprehensive range of liquid and less liquid, global and regional solutions tailored to accessing the broad and evolving investment opportunities within emerging markets. l
The opinions stated are honestly held but are not guaranteed and should not be relied upon. Nothing in this article should be construed as investment advice.
Richard Garland is managing director at Investec Asset Management. He can be contacted at:
richard.garland@
investecmail.com
44 bermuda captive 2012
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