Emerging market equities (EM) has been taking a beating since Trump won the US election. The rise in the US dollar particularly against the Yen and Euro. This is primarily driven by the rise the relative yields and it is too early to say if the market forecast in rising inflation or real yield will be correct.
As a direct consequence of rise in the US dollar, emerging market indices has been taken a beating. It has missed the rally as the risk of trade protectionism will increase under a Trump administration. Traditionally, emerging market performance also had a strong correlation to the US dollar. Paradoxically a strong US dollar means a weaker local currency, which should help export competitiveness. However in this instance, a strong dollar signifies weaker confidence in the emerging market and potential shift of capital flow back to the US.
We think the strong dollar will eventually hit us equities. The S&P 500 is made up a multi national companies where overseas income makes up a large portion of its earning base. A stronger dollar will eventually flow to the income statement if there is no corresponding increase in underlying growth.
Considering our contrarian streak, we feel that shifting a portion of portfolio allocation EM from developed markets.
How to get emerging market exposure in the portfolio
Emerging Market ETF
Easiest and traditional means of gaining EM exposure in the portfolio is through Emerging Market Exchange Traded Funds. This is a shot gun approach in investing in riskier markets as every dollar invested in these funds are spread across numerous countries. It is the cheapest and most liquid means of having emerging market shares in the portfolio. The portfolio would be a mix of developing market equities across multiple countries which provides a strong diversification benefit whole maintain sector exposure.
Emerging Market Country ETF
A second option is to use country specific index funds. Not all EM markets are equal. Some have better risk and reward profiles than others. By choosing country exchange traded funds, this would avoid some of the weakest members of the group. This is for those that are more comfortable in attempting to pick winners and losers. The advantage of this approach is it still bypass the need to find specific stocks and just go with the market.
Emerging Market Stock Picking
We always considered our selves to be active stock pickers. Hence our exposure to EM equities would be primarily through specific names in local markets or mature companies in developed markets that has large developing market exposure.
The approach we take allows us to pick specific exposures in balancing risk and reward based on our view and leverage our background and experience in specific sectors. It requires more work but that is part of the game, either put in the work or go passive. This does not come without risk. Since we are further away from the key market, additional work is required to understand the company’s market, product and competitors.
An example of this approach is Telefonica. Telefonica is a Spanish telecom akin to Telstra. It has major exposures to Europe through owning O2 in UK, Telefonica and large play in its home market Spain. In addition, it owns large stakes telecom companies across Latin America with the most important stake in being Brasil.
It used to be a market darling but recently the slower European growth coupled with crash in investor confidence in Latin America means that it is out of favour with the market. A leveraged balance sheet does not help.
We see it turning the corner given the recent cut in dividend and there has been signs of pick up across a number of sub markets. It is an interesting position.