By Raman Subramanian
Apart from a recent swoon spurred by fears that the US Federal Reserve could raise rates, it was a summer of love for investment in emerging markets.
The MSCI Emerging Markets Index ended August up 15% for the year, after losing 20% in 2015. Compared with other rallies of recent years, much of the latest one has skirted China. Brazil (up 62% through Aug. 31), Taiwan (up 18%), South Africa (up 16%) and India (8%) – to cite four countries that have contributed to the rally – all have performed well, but each has performed well for different reasons.
The disparity highlights the differences among the 23 countries that constitute the MSCI Emerging Markets index. To illustrate this phenomenon, we have examined the performance of each of the four countries cited above through the explanatory variables of countries, currencies and sectors.
The analysis examines the sources of performance within each country and expands on a view that institutional investors can access with MSCI’s interactive heat map, an online tool that captures the daily performance for single country indexes within emerging, developed and frontier markets.
Viewing emerging markets through the lenses of currencies, countries and sectors
The country factor is historically the largest driver of return differences in emerging markets. 2016 is unfolding similarly. This factor captures political, regulatory and governance risk. Data shows that, through August, investors repriced sovereign risk in most emerging market countries. The contribution of the Brazilian country factor stands out in light of that nation’s tumultuous year politically.
Country and currency factor contributions to emerging market returns
The broad basket of emerging market currencies has appreciated against the dollar as US interest rates have remained stable. Yet, there has been a disparity within the group. Two Asian currencies – the Chinese yuan and Taiwanese dollar — have fallen relative to other emerging market currencies this year. However, in Brazil and South Africa, currency appreciation has rivalled the country component of return.
Style and industry effects can be substantial, based on MSCI’s risk model, which contains factors tailored for emerging markets. The oil sensitivity factor is one such example, quantifying movements of oil prices for firms inside and outside the energy sector. Positive return to this factor represents a basket of stocks that tend to do well as oil prices rise.
The effects of oil and other export-related industries such as gold and precious metals, electronics and components, and automobiles and components, in Brazil, South Africa, Taiwan and India, has been varied. Brazil’s economy tends to reflect the price of oil and has benefited considerably from the rebound in crude prices. Our research and data suggests that the return contribution of oil for Brazil to be as high as 2.5%, based on year-to-date data as of August 31st and using MSCI’s Emerging Markets Risk Model to show returns relative to the MSCI Emerging Markets Index. However, financials (36%) and consumer staples (18%) each outweigh energy (13%) in MSCI’s Brazil Index.
Style and industry factors
South Africa’s concentration in precious metals rewarded investors, accounting for a return contribution of 4%, based on the same year-to-date data as of August 31st. But investors should note the country’s sensitivity to oil prices: Sasol, an international energy firm, at 5% of the index, is the third-largest constituent.
Taiwan participated in the rally through its electronics industry, which constitutes nearly 60% of the sector weighting and contributed a return of approximately 1.5%. India, which like China can represent a proxy for emerging markets in some portfolios, has not enjoyed the currency and commodity bump that Brazil and South Africa have. Still, India had tail winds from its automotive industry, which constitutes nearly 15% of the sector weights.
A broad-based emerging markets allocation has been effective in capturing the dramatic transformations of emerging economies over the last 20 years. But as a review of the performance of emerging markets this year highlights, countries that share characteristics can differ dramatically in drivers of return. The differences have offered opportunities for investors.
Raman Subramanian is head of Equity Applied Research at MSCI
