For institutional investors, the current market crisis might prove to be an opportunity, Joseph Mariathasan writes
Just a few weeks ago, I wrote that August is often quiet for markets and may be the right time to think about preparing for the next inevitable crisis. But that market ‘crisis’ appears to have come much sooner than anyone expected. As a result, institutional investors will be forced to decide how to react, regardless of whether they have a well thought-out plan of action in place or not.
As I warned previously, institutional investors are often forced to reduce risk exposures in a crisis, which means selling equities at the bottom of the market. One reader’s first reaction was to object and say “Of course they don’t have to sell at the bottom, unless their clients tell them to”. He is, of course, perfectly correct, but the issue for many managers is that they dare not risk the possibility that markets have not yet reached bottom, and they are faced with the prospect of having to explain even larger losses to clients. That holds true even for institutions with supposedly long time frames.
To ascertain how much of the crisis is real and how much the result of exaggeration or poor analysis, at a time of thinly traded markets over a holiday period, is important. But this is proving difficult. Even the Financial Times (FT), in mid-August, was guilty of sensational headlines, according to Jan Dehn and Alexis de Mones at Ashmore, when the news daily declared that emerging markets had suffered $1trn (€891bn) in capital outflows over the past year or so.
In fact, the actual outflows were much lower – somewhere between $183bn and $295bn, according to Ashmore. The asset manager claimed the FT had made a basic accounting error in failing to include foreign-exchange valuations in their calculation of capital flows (capital flow = change in reserves - current account flow - FX valuation effects).
Once included, the FX valuations produce much lower figures, measuring between 0.6% and 0.9% of total tradable debt and equity in the emerging markets. As Ashmore points out, this means the outflows – rather than being more than twice the amount recorded in 2008-09, a point laboured by the FT – are, in fact, significantly smaller and perhaps even as low as half that size.
Emerging market news may be subject to exaggeration, but is the crisis we are seeing in these markets, as Ashmore suggests, the ‘canary in the coal mine’ – a symptom of something far bigger and far worse? Over the last four years, the biggest influence on global capital markets has been the massive QE programmes in the US, Europe, Japan and the UK, with the US equity and European government bond markets soaring in response. Yet Ashmore argues that herein lies the roots of the current global nervousness, with overvalued asset prices, weak, unproductive and heavily indebted economies and no obvious way forward.
If Ashmore is right, the global problems reside in the developed markets, while emerging markets now look even cheaper. Not only have the actual outflows been much less than the FT indicated, they also appear to be linked to retail mutual funds and ETFs. Institutional investors with long time horizons may be able to achieve outperformance by doing the opposite of the retail investors who have been following the news headlines. Indeed, for those with low allocations to the emerging markets, the crisis just might prove to be an opportunity.
Joseph Mariathasan is a contributing editor at IPE