Emerging markets," a term coined nearly 30 years ago, no longer does justice to a category of investments that cover a wide array of asset classes and countries, according to a white paper from Standish Mellon Asset Management Company LLC, the fixed income specialist for BNY Mellon Asset Management.
"We believe the term ‘emerging markets' is a deficient investment concept as it is inconsistent and vague," said the paper's author, Dr. Alexander Kozhemiakin, managing director and senior portfolio manager at Standish. "Traditional divisions between so-called developed and emerging markets are blurring, as some countries in the former category display higher levels of risk and a more serious degradation of fundamentals than countries in the latter."
The Standish report proposes a new concept of "assets tied to economies of risky countries," or "ASTERISCSsm." It better conveys the appeal and risks of emerging markets and allows for the inclusion of markets of developed countries that start behaving as emerging, the report said.
A glaring example of the failure of the term "emerging markets" is that it simultaneously refers to markets as well as countries, according to the report. This can cause confusion, the report said, as a single country can have multiple markets, such as equities, bonds, currencies, real estate, each with different characteristics.
""It is possible that a country classified as 'emerging' can have a relatively mature, liquid market," Kozhemiakin said. "Conversely, the presence of mature, liquid markets does not necessarily mean that a country in which they are operating is risk-free."
The vast majority of country risks are linked to the same factors that explain why certain countries are not yet rich, defined by gross national income (GNI) per capita, according to the report. However, rich countries can also become risky, if they are confronted with an external threat, or face high domestic political risk, or suffer from major debt sustainability problems, the report notes.
Impaired creditworthiness is a country risk because default on public debt is a systemic event that has the potential to negatively affect the performance of all asset classes tied to the economy of that country, Kozhemiakin said.
Thinking about assets tied to the economies of risky countries, or ASTERISCSsm, instead of as emerging markets helps to illuminate their two main roles in a broader portfolio, according to the report. These two roles are:
Taking on the elevated country risk (in addition to other types of risks specific to their respective asset classes) can potentially enhance returns.
ASTERISCSsm can diversify the country risk of existing portfolios even though they expose investors to countries with high risk.
"This diversification is a significant benefit, especially considering the home bias of many portfolios," said Kozhemiakin. "In addition, there is a growing recognition that the asset classes of developed countries, where many portfolios tend to be concentrated, are not necessarily immune from becoming ASTERISCSsm themselves."
The concept of ASTERISCSsm encourages a multi-asset class approach to risk management by highlighting that country risk cuts across all asset classes, according to the report. Kozhemiakin said, "In addition to determining the overall amount of ‘emerging market' equity or fixed income in their portfolios, investors would be well served by evaluating their total exposure to individual risky countries."
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