Some commentators have declared the demise of emerging markets (EM) as an asset class. Globalization has reversed, they contend, noting that over the past five years EM asset returns have been subpar relative to those in developed markets (DM). Indeed, growth in emerging markets has slowed since the global financial crisis, while DM economies and markets have benefited from unconventional monetary policies. Yet facts on the ground and careful analysis argue against the narrative of DM dominance. Over the secular horizon, we believe there is a strong structural case for EM assets.
We begin with a broad analysis of beta and alpha opportunities in both emerging and developed markets. We focus on ex ante measures of risk premia and relative value to estimate beta and alpha. The paper assesses whether greater macroeconomic risks in emerging markets explain higher estimates of returns for emerging economies than for developed economies.
Using a risk taxonomy associated with EM crises, we consider the current balance of risks in emerging markets compared with their DM counterparts.
Our conclusions are threefold:
1) Using standard metrics, estimated returns in emerging markets compare favorably in equity, currencies and fixed income.
2) Despite a rich catalog of crises that have boosted EM risk premia, crisis risk has risen substantially in developed markets, suggesting that DM risk premia have room to adjust higher.
3) Investors are generally underallocated to EM equity and fixed income.
In sum, with regard to valuation, liquidity and systemic risk, we believe there is a strong structural case for EM assets. Quite possibly, the last shall be first.
Read about PIMCO’s constructive view of emerging markets in 2019 in “Emerging Markets Outlook: The Wealth of Nations.”