Schemes back diversity to ride out EMD volatility

Emerging markets have suffered ever since talk began in May last year that the US was to taper its quantitative easing programme, sparking concerns among investors over liquidity and potential interest rate hikes.

This was compounded by deepening currency problems in early 2014. Data reported by the Financial Times show January had large equity outflows from emerging markets as investors took $12.2bn (£7.5bn) elsewhere.

Pension funds invested in local currency-denominated debt have been most exposed to the crisis, while those in dollar-denominated assets have been protected from some of the volatility.

But nearly all have suffered in the short term. The leading EMD index, the JP Morgan EMBI, has fallen sharply since its market highs last May.

“We’ve constantly said to our clients that they should be diverse,” said Ed Britton, fixed income senior consultant at consultancy Towers Watson, in Thursday’s edition of The Review.

“Crises come and go and you shouldn’t have all your eggs in one basket.” Having both local currency and dollar-denominated assets has stabilised returns, he added.

Colm McDonagh, head of emerging market fixed income at Insight Investment, said the sell-off had been encouraged by investors that had wrongly assumed EM currencies would appreciate against developed-market currencies over the long term. “It is unwinding of that long position at the moment which is creating some distress in the market,” he added.

Managers are presenting the sell-off as an opportunity. “The reason for owning EMD – to capture that risk premium – is now back in the market, so there is some value there,” said McDonagh.

This year’s EMD survey sees managers sticking with tried-and-tested investments and again putting Mexico, Brazil and Russia as the top three targets for foreign investment.

Click here for the first part of Pensions Expert's 2014 EMD survey