Emerging markets: last refuge in a low-return desert?

Traditional risk premia are currently subdued, and interest rates in key developed markets look likely to remain historically low for some time, leading investors to look elsewhere to generate returns.

We believe that emerging market equities and bonds offer compelling opportunities through their improving fundamentals and attractive valuations. The outlook for developed economies remains weak: heavy debt burdens, declines in potential growth and the inability of policy makers to deploy impactful fiscal policy imply that monetary policy (manifested in low rates) remains the only source of stimulus. Even in the US, where economic conditions are much stronger than in other key advanced economies, the risk of negative external shocks have prompted the Fed to take a very cautious stance, which has been reflected in declining long-term growth and interest rate projections.

From an investment perspective, an environment of sustained low yields and weak expected returns (reflected in expensive valuations across most of the developed world) is leading to renewed focus on emerging market (EM) asset classes. Over the 2013/15 period, EM assets came under considerable pressure against a backdrop of weak economic fundamentals, a sharp increase in idiosyncratic risks (such as in Brazil and Russia) and the broad-based rise in the USD.

However, we now believe that the case for the asset class is becoming more positive. This is based on a risk/reward assessment of three key aspects, namely fundamentals, valuations and risk factors. On the fundamentals front, recent data shows a pickup in economic activity alongside a visible improvement in the external balances of a number of emerging economies. Focusing on valuations, despite the improvement in fundamentals, the current situation is reminiscent of 1997-98 crisis-type pricing, while potential systematic risk factors emanating from a China-centric financial meltdown and a hawkish Fed are starting to fade.

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Past performance does not guarantee future results.
Emerging markets securities may be less liquid and more volatile and are subject to a number of additional risks including, but not limited to, currency fluctuations and political instability.
If investments are denominated in a currency other than that in which the majority of the investor’s assets are held, the investor should be aware that changes in rates of exchange may affect the value of the funds’ underlying assets. The portfolio risk management process includes an effort to monitor and manage risk, but does not imply low risk. Issued by Lombard Odier Asset Management (Europe) Limited, authorised and regulated by the Financial Conduct Authority (the “FCA”), and entered on the FCA register with registration number 515393. ©2017 LOIM. All rights reserved