It’s a small but important example: In the six months ending late July 2016, the tiny Philippine Stock Exchange—with a total market cap that’s roughly two-thirds the size of Thailand’s or Indonesia’s—advanced more than 30%. But then, not long after the fast-growing nation’s election of controversial new president Rodrigo Duterte, there came an about-face. By mid-October, the benchmark had dropped nearly 8% from its apex.
Volatility is normal in emerging markets. But no one can deny that Duterte has racked up some wild headlines. He’s encouraged if not ordered the killing of thousands of accused drug users and their dealers, insulted President Obama, offended the European Union, kicked U.S. forces out of his country and pivoted toward improving relations with China and Russia, and then reversed himself, among other incendiary moves.
“Duterte is, for lack of a better word, scary to a lot of investors,” says Charles Sizemore, a portfolio manager at Covestor and principal of Sizemore Capital, a registered investment advisor in Dallas. “Large institutional investors tend to shy away from controversial regimes.”
Emerging markets investments are often buffeted by this kind of regime change. “The situation in the Philippines highlights the risks involved with emerging markets, especially when erratic government behavior is involved,” observes David Clausen, a Los Angeles-based wealth management advisor with Northwestern Mutual.
Latin America
Some emerging market portfolio managers are currently preferring select Latin American equities. “There are better opportunities in Latin American emerging markets, given that they are a direct linkage to commodity prices,” says Jack McIntyre of Philadelphia-based Brandywine Global Investment Management, a subsidiary of Legg Mason.
In particular, McIntyre likes the “valuation anomaly inherent in more commodity-based EM markets,” he says, singling out Mexico.
Still, sovereign risks can come into play. In Brazil, for example—the largest LatAm market—a current concern is that “the government has been outspending GDP growth,” says Louis Lau, San Diego-based manager at Brandes Investment Partners. “The big question is whether the new government under President [Michel] Temer [who took office on August 31, 2016] will pass a proposed bill to cap fiscal spending.”
Lau further notes, however, that Brazil’s political landscape seems to be moving to a “center-right position, as opposed to favoring the leftist policies of old, and that looks like a positive for the market,” he says. So he remains overweight on Brazil.
Emerging Europe
Other sovereign concerns are causing Lau to keep a close eye on Turkey and Russia. Last summer, a failed coup attempt in Turkey stirred up a great deal of distrust. “President [Recep Tayyip] Erdogan has been using the attempted coup as an excuse to purge antigovernment sentiments … and consolidate power,” says Lau. “Historically, Turkey has been more of a secular country, but now we might see it become more fundamentalist in terms of Islamic tendencies.” That, he adds, would be a “negative for the democracy and the equity markets there.”
As for Russia, the key pluses are declining inflation, high interest rates and political stability. Low oil prices have led to a decline in dollar inflows, but the Russian central bank “has been making some wise economic policies,” says Lau. “The depreciation of the local currency is actually beneficial for Russia’s domestic economy, because it’s allowed social spending to be kept up, in ruble terms.”
That means a relatively content population, which in turn indicates little chance of a change in government. Whether or not you like Vladimir Putin, the stability is a positive attribute from an investment perspective. “If the political situation deteriorates in any of these countries,” Lau advises, “that might be a reason to turn more cautious.”
Debt Markets
Beyond equities, emerging market fixed-income and currency investors must pay attention to sovereign risk as well. Simon Lue-Fong, head of EM debt at Pictet Asset Management, headquartered in London, is keeping close tabs on the regimes in Argentina, Colombia and Venezuela.
“Argentina is moving from a socialist/left-leaning and personality-driven government to one where you’ve got competent and able policymakers in place, with a clear reform agenda,” he says. President Mauricio Macri, who was elected in November 2015, is trying to “get inflation down,” he adds, and has taken steps to “liberalize the exchange rate”—all reform measures he finds promising. “There’s going to be some pain, obviously, but they’ve taken some big steps already.”