Contagion and volatility reduction contribute to change in regions

The face of emerging markets appears to have changed recently with a reduction in contagion and volatility, accompanied by a new type of investor exhibiting long-term ambitions.

But the opinion of fund managers is divided on whether there has been a long-term change to investment in the asset class, or whether this is a misinterpretation of events that could go wrong for investors.

Rob Brewis, investment manager at London-based fund manager, BDT, believes there has been a long-term shift, which is particularly pronounced in Asia.

Asia is one of the lowest beta markets in the world at the moment, he says, partly due to low valuations and few sellers, but also due to fundamental support of the markets.

This reduction in volatility changes the perspective fund managers have on emerging markets, according to Brewis. They have traditionally been seen as places to invest for higher-risk exposure, but that is no longer necessarily the case.

It also means Asia, as a geared play on global recovery, is not as good a bet as it once would have been.

Asia has the lowest volatility of emerging markets, normally attributed to lower levels of sovereign and corporate debt. Contagion between markets caused by irrational investor behaviour ' traditionally a characteristic of emerging markets ' has reduced, or in some cases disappeared, says Brewis.

'If you go back to Russia ' when that blew up it sent waves round emerging and developed markets,' he says. 'When Argentina blew up it had limited contagion. There seems to have been a change as people realise that just because Argentina defaults, does not mean others will necessarily do the same.'

In Latin America, Brazil has exceeded expectations since its new left-wing president Lula came to power last year, according to Brewis.

'Commodities have had a good run recently and certainly Brazil has benefited from being an exporter. If you expect this to continue in the medium term, then that will be good for Brazil.'

The SARS epidemic that has hit Hong Kong has initially had a negative effect on the market there causing uncertainty, but this is unlikely to be prolonged, he adds.

Doctors have determined the virus is not airborne and its spread has been limited. 'Investors will quickly forget about SARS once it is under control and it will have little effect on markets,' says Brewis. 'These types of events have an immediate impact, but are not destabilising.

'The effect of the Iraqi war on emerging markets could be significant, but is difficult to predict. Oil price swings will have different effects on emerging economies, depending on whether they are oil exporters or not,' he adds.

One increasingly important factor in the oil markets going forward will be demand from China. The country continues to look for more oil on its own soil, but the rise in demand there has been 'staggering' leading to it becoming a net importer, says Brewis.

Jerome Booth, head of research at emerging markets specialist, Ashmore, agrees emerging markets have undergone a long-term change.

Emerging markets are popular in the current environment as they are anti-cyclical to the global business cycle, have a negative correlation to global bonds and provide natural protection from the global oil cycle, he says.

There has been much progress that has not been priced into emerging market bonds, leaving it massively under-priced, according to Booth.

'Russia, Brazil and Mexico are the most attractive positions in the asset class,' he says.

Brazil is recovering fast from an uncertain period before the recent election of Lula. 'It has no major problems, but is valued cheaply,' says Booth. 'Lula has been a success so far, but the market thought he wouldn't be.'

Once interest rates start to come down and growth becomes stronger the picture will look even better, he adds.

'Mexico is attractive as it is an investment grade country with cross-over investors from the US. Russia is in a rally, has recently received a huge investment from BP, and reform there is continuing at pace. On top of this the macro environment looks positive,' says Booth.

Peter Lucas, global investment strategist at Ashburton, is more cautious. 'Emerging market debt has performed well, but if circumstances change so could performance,' he says.

Contagion is still a problem in emerging market debt, according to Lucas. 'When Latin American credits move they all move together subject to specifics,' he says.

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