EM RISKS: Unsettled forecast follows Arab Spring

rusty-tractorThe uprisings in parts of the Middle East and North Africa may not have had a direct impact on investments, but the reverberations will certainly be felt. Angele Spiteri Paris reports The civil unrest in the Mena region may have led to some emerging market outflows earlier in the year, but experts say that any recent redemptions are more a result of inflation worries. However, some of these concerns can still be traced back to the political uprisings in this oil-rich part of the world. Although on a high level, fund managers say that the turmoil in the Middle East and North Africa (Mena) region did not affect other emerging markets, the truth is that, indirectly, the whole of the asset class has felt some strain. The one tangible effect of the political turbulence in countries such as Tunisia, Egypt, Bahrain and Libya is the rising oil price. Rami Sidani, head of Mena at Schroders, says: “The only direct effect of the Mena trouble on other emerging markets is the surge in the oil price.” He says that when news of the unrest first broke, the main concern was mainly contagion into Saudi Arabia. “Investors were worried that the turmoil would spill over into Saudi Arabia and disturb all oil production.” Greg Saichin, head of high-yield and global emerging markets at Pioneer Investments, says: “There were fears that oil operations were going to be disrupted. Analysis shows that the impact of seeing so many oil producing countries having civil unrest leads to expectations of raised oil prices.” One worry is that if the oil price continues to rise, the effects of it may lead to food inflation, which may in turn lead to further civil unrest in other emerging markets. Saichin says: “Poorer energy resource countries will suffer as a result of the rising oil prices as this will also leak into food prices and lead to a certain amount of instability.” Judy Posnikoff, founding partner at hedge fund firm Pacific Alternative Asset Management Company (Paamco), says: “The oil price will have varying degrees of impact, depending on the levels of food inflation.” According to Nitin Jain, principle fund manager at Indian firm Kotak Mahindra (UK), any withdrawals from emerging markets have more to do with inflation concerns than political worries. “The outflows from emerging markets seen in the last few months were a result of internal dynamics, such as inflationary issues in India, rather than anything else. North Africa did contribute a little, but not much.” Posnikoff agrees: “Inflation worries were the primary driver of risk aversion and the resulting outflow from emerging markets. The January and February outflows were due to the uncertain political environment, but since then inflation issues have become more of a key driver.” Data from fund tracking company EPFR Global showed that in the first quarter of the year emerging market equity funds saw outflows of $24.5bn (€17.02bn). Although flows improved towards the end of the quarter, in mid-May they once again saw redemptions of $1.64bn. But as Posnikoff explains, inflation worries and potential political upheavals are also closely linked. She says that civil uprisings could happen anywhere and are often driven by food inflation. “A while ago, we had unrest in Thailand and, in 2008, there were riots in Mexico as a result of raised corn prices. This shows that these issues could pop up anywhere, even in places you wouldn’t expect,” she explains. Frontier markets
The uncertainty around the oil price has led to some fund managers making changes to their portfolio positioning. Saichin says that as a result he is underweighting energy and commodity-poor countries, mainly South Africa, Turkey and India. Jain adds: “Due to the surge in oil prices, investors may want to be underweight energy deficient countries, such as India. He warns that although the direct impact of the Mena trouble has not been felt, “indirectly it will impact on everyone because of higher oil prices [and increased political risk premium]. Also investors’ aspirations need to factor in higher risk in investing in some frontier markets.” And it seems that the markets have felt this uncertainty. Daniel Wood, fund manager at Rexiter, a specialist emerging market investor with $4.5bn under management, says questions around the discord in Mena were very popular. “The most asked questions by clients and prospects earlier this year were, ‘How is the civil unrest going to affect my holdings?’ and, ‘How are you positioning yourselves?’” he says. “Uncertainty is the market’s biggest enemy,” says Sidani. Matteo Pardi, head of wholesale for continental Europe at HSBC Global Asset Management, agrees: “Political turmoil does create volatility and nervousness in markets. Because of the instability, asset allocators have reduced some overall risk from their portfolios. In addition, there has been some level of profit taking following the strong growth experienced in emerging markets. One might question whether the turmoil in North Africa has led to the creation of additional risks for emerging market investment as a whole.” Jain says: “Political risk would have gone a couple of notches higher in terms of investor perspective.” Wood says: “One of the things that changed in the way investors look at emerging markets [post-Mena turmoil] is the way they view political risk. They now take a closer look at the regimes in these countries.” Whether political risk has increased or not also depends on which emerging market countries we are talking about. Posnikoff points out: “There are regions where political risk has increased and investors need to be careful, especially in countries where there is no democracy.” Running scared
A spokesman for Dutch manager APG Asset Management, the spin-off from pension giant ABP, says: “Not having dealt with huge strings of political unrest in 2009 and 2010 did perhaps lead to the conclusion among some market participants that Gem [global emerging market] investing did not go hand in hand with political risk.” But the long-term believers in emerging markets are not to be scared by inflation worries or potential civil unrest resulting from raised food prices. Pardi says: “Investors taking a long-term view are still invested in those markets.” Actually, astute investors may say that now that the herd has been scared off, the buying opportunity is ripe. Sidani says: “I don’t think investors have been scared off emerging markets. Change means opportunity and, therefore, long-term investors are actually keen to position themselves to benefit from the opportunity post-turmoil.” Saichin agrees: “We’re still in a sweet-spot phase and, notwithstanding the increased inflation and food and oil prices, the outlook for growth in emerging markets is still very good.” Posnikoff’s colleague, Alper Ince, partner and sector specialist at Paamco, says that further outflows from emerging markets is a good thing. “If retail investors panic and get out of the markets on a broader scale there will be dislocations, and any manager with local knowledge will have an edge over those who misunderstand the story.” Most large institutional investors, such as Dutch pension fund PGGM and the Swedish buffer fund would not comment on their emerging markets investments and whether they were at all impacted by the troubles in the Mena region. But APG Asset Management, which is close to its ABP pension fund parent, says: “Recent events in the Mena region did not impact our longer term view on global emerging markets.” Wood, at Reixter, says that investor sentiment for emerging markets is still strong. “At meetings with prospective clients, we’ve found that sentiment is still strong and institutional investors are actually looking to increase their allocation to emerging markets further down the line,” he says. ©2011 funds europe

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