What a Messi! Avoiding Argentina
- Country selection is an often overlooked but crucial consideration in emerging market investments
- Emerging market countries have specific characteristics that makes country selection so important
- Argentina is a prime example of this
Why country selection in Emerging Markets is so important
As many investors look to global equities to diversify their portfolios, the uncertainties in many developed markets have put the spotlight on emerging market investments as a more mainstream source of potential returns. Given that South African investors tend to be overweight SA, underweight Global Developed Markets and underweight Global Emerging Markets in terms of their personal portfolios, this is an encouraging trend – but it also brings to light one of the most crucial (and often overlooked) considerations for investors, particularly when it comes to emerging market investments: country selection.
For our new Best of Breed™ fund manager NS Partners, who we have partnered with to manage the Nedgroup Investments Emerging Markets Equity Fund, country selection is a central part of their process. They will not hold any companies in a country which their research suggests is not currently investable. Below we consider recent the recent situation in Argentina as an example.
Country selection in emerging markets
Emerging market investing has a number of additional characteristics to consider that makes diversification and country selection so important:
• Emerging Market currencies are significantly more volatile both relative to the USD as well as relative to each other. In general, heightened global risk aversion reduces the appetite for Emerging Market currencies, leading to weakness, and vice versa.
• Emerging Market equities tend to move with a high correlation to their local currency, weakening or strengthening in tandem, which exacerbates volatility to an overseas investor.
• Country specific political risk tends to be more pervasive
• The components of the stock market index within each country may be dominated by a narrow range of influences, such as specific commodities.
• The openness of a stock market to international investors may have a pronounced effect on demand.
These factors lead to higher variability of investment returns, but also create opportunities for those who have a rigorous approach to country selection in place.
The chart below shows the annual returns of the MSCI Emerging Markets Index (light green horizontal dash) going back all the way to 2004.
Source: Refinitiv, NS Partners
The vertical dark green bars demonstrate the range of returns, from the highest to the lowest, for the individual countries that comprise the emerging market index. The countries which define the range in each year have also been identified within the graph. For example, in 2004 Thailand delivered the worst return of the year, while those investors in Colombia would have earned almost 150% in USD.
This chart demonstrates the high dispersion of returns within Emerging Markets, as well as the importance of avoiding the disasters and being overweight those countries with tailwinds behind them in order to add value within a portfolio context.
In practice: Argentina as an example
The graphs below make it clear that Argentina has suffered severe blows as a country, which in turn would have significantly affected anyone invested in the stock market recently, irrespective of the quality of the businesses that were held.
1. The currency has depreciated significantly over the past few years:
2. Government debt has been rising:
3. Along with rising unemployment: