Allianz SE : Rethinking emerging markets

Mohamed El-Erian, Chief Economic Adviser of Allianz

The concept of "emerging markets" (EM) has long had considerable influence on how investors distribute their capital. Today, these markets are increasingly differentiated in terms of fundamentals while also vulnerable to the influence of short-lived trends. This encourages investors to look with fresh eyes at both long-term opportunities and risks. In this summary of a recent Bloomberg article, Mohamed A. El-Erian explains the three pillars of an asset class and points out where the class of emerging markets are about to develop further.

1. Over the past few years, different emerging markets have grown in markedly different ways. They were previously characterized by shared geographical, economic and financial characteristics. These similarities allow investments to be compared in terms of expected returns, volatility and correlations with other asset classes.
   
   This possibility has been lost as a result of differentiation of the characteristics mentioned above. In addition to this, EM has grown markedly since its relatively modest beginnings, and it now contains far too much diversity to meet the first requirement of shared characteristics.
2. Second, the majority of the components of the asset class are sensitive to an external influence that is strong enough and sufficiently encompassing to have a similar impact across the board. This can take the form of a single variable, such as the price of oil for producers, or it can be linked to a policy, such as the effect of the European Central Bank's quantitative easing on sovereign bonds.
   
   EM no longer qualifies for this criterion, especially now that the comments and actions of a single policy-making body, such as the International Monetary Fund, don't move markets as they once did.
3. The actions of investors previously had a self-reinforcing effect on the development of asset classes and the way in which their individual components related to one another. This happens when many investors focus on the same targets or when markets are overwhelmed by large tides of capital.
   
   This pillar is still intact, giving rise to interesting dynamics. Macro decisions to allocate or withdraw capital from EM tend to be significant drivers of return, volatility and correlation behaviors. Particularly if they are influenced through index and index-like vehicles. This leads too often to valuations that are decoupled from individual fundamentals.

All in all we have to recognize that EM is in a technical phase of unsettling volatility. It also means that individual components of the asset class will tend to trade cheaply relative to intrinsic values.

The article "Rethinking Emerging Markets" by Mohamed A. El-Erian was first published on Bloomberg View. Edited and adapted by Allianz.com team.

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