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.”

In particular, Lue-Fong cites Argentina’s three bond issues in 2016, which altogether raised more than $20 billion. This was a significant return to capital markets after the country’s 2001 default on more than $1 billion in sovereign debt. “They’ve managed to settle the old debt and issued the biggest bond transaction this year,” he says.

Colombia is another story. “I’m getting ready to like Colombia because of the peace accord there, despite the disappointing referendum,” says Lue-Fong, referring to a deal reached last summer between President Juan Manuel Santos and the FARC rebel group, which was subsequently defeated in a popular vote. “I’d like to believe they will get back to the negotiating table and eventually there will be peace, but I’m just not clear on the time line.”

Venezuela may be an even more complex situation. “The government of President Nicolás Maduro seems ready to start normalizing the political and economic system,” explains Lue-Fong. “Though it’s still risky at the moment, I do expect change in Venezuela in the next 12 to 24 months because the country is reaching a breaking point.”

For Lue-Fong, a similarly guarded quasi-optimism applies to South Africa, where the central bank has “become very credible,” he says, “and the Ministry of Finance is running a tight ship.” But inflation has remained at 6% or higher all year—cresting at 7% in February 2016—with little hope of easing from an interest-rate cut. “With little room to maneuver, the government of President Jacob Zuma is stuck between a rock and a hard place,” he says.

It’s All In The Timing
Whether you’re looking at equity or debt, success or failure can depend on the timing. So, in general, is 2017 a good entry point for emerging market investing?

“We expect broad outperformance across all the EM regions in 2017,” says London-based Paul O’Connor, head of multi-asset at Henderson Global Investors. “The combination of cheap currencies and improving macro momentum, which we see as the key drivers of EM assets in 2017, is well represented across emerging Asia, LatAm and EMEA [Europe, the Middle East and Africa.]”

To O’Connor, emerging market equities appear more attractive than debt. The equities, he says, stand out “given their valuation support and leverage to improving cyclical fundamentals. Although EM debt should remain well underpinned by the global structural hunt for yield, we do not think it can detach from the episodic setbacks fixed-income markets are likely to experience in 2017 as growth recovers and central-bank support recedes.”

Sizemore at Covestor also makes the case for equities. “Emerging markets as a bloc are cheap relative to developed-world stocks,” he says, adding that the most sensible strategy is to buy “a diversified basket.”

But bonds do have their champions. “EM debt is a relatively safe investment with good yield,” says Luis Maizel, co-founder and senior managing director of LM Capital Group in San Diego.

That yield can depend on many factors. “Dollar-denominated sovereign EM debt could have a bit of difficulty if interest rates here in the U.S. rise,” says Clayton Fresk, a portfolio manager with Stadion Money Management in Watkinsville, Ga. This, he suggests, might make bonds denominated in local currencies a better bet—depending on exchange rates. Such bonds, he says, are often “a bit higher quality” but come with “added volatility from the associated currency exposure.”

China Risk
Yet Katrina Lamb, head of investment strategy and research at MV Financial in Bethesda, Md., sees challenges ahead for emerging market investments due to “continued weak demand trends in much of the developed world, and the still-present—if not necessarily headline-making—threat of weakness from China.”

Indeed, China has been a worry for investors in this space for some time, largely because of its size and economic power. “It is still a concern,” insists Lamb. “China’s economic influence on the emerging Asia region is dominant.”

Others hold a more moderate view. “There is risk of a significant China slowdown and its effect on other countries—primarily ones that sell commodities to China—but markets seem to be less concerned about those tail risks now,” says Eric Stein, a vice president at Eaton Vance in Boston. He says a significant economic stimulus from Chinese policymakers has “goosed the economy.”

Maizel, at LM Capital, might agree. “The China contagion has dissipated but has left some after-pain,” he says. “It remains the biggest equity piece in all EM indices, [but] the rebound of other countries proved the contagion is much less than it would have been a few years ago.”
McIntyre at Brandywine puts it another way: “Don’t lose sleep over China. It’s not a concern right now because I don’t see China derailing in the near term.”