“Whatever you say about emerging markets risk, there is no question that developed markets risk has gone up as a result of Brexit,” said Julian Mayo, co-chief investment officer in London at Charlemagne Capital Ltd. “Clearly, it increases U.K. risk,” which he said was evident immediately on ratings agency S&P Global Ratings' decision June 27 — just four days after the vote — to downgrade the country's credit rating. There is also a risk for Europe, in the encouragement for other euro-skeptic countries, Mr. Mayo said. “It has unquestionably changed, I think in a very significant way, the relative risks associated with emerging markets and developed markets.”
Richard Titherington, Hong Kong-based head of emerging market equities at J.P. Morgan Asset Management, said clients have this view, too. “One of the things we have seen — and in Asia this was a message from clients — (is that) Brexit has reminded people there are risks in developed markets as well; people would have perceived the U.K. to be a low-risk investment pre-Brexit.” Emerging markets now “appear less relatively risky than” before the U.K. vote.
Brexit also has implications for global and regional growth. Last week, the International Monetary Fund published its latest World Economic Outlook Update, in which projected global growth rates were reduced due to the vote. The revised 3.1% projection for 2016 is flat vs. 2015 estimates, but a 10-basis-point drop from the April update. For 2017, the growth forecast also was cut 10 basis points, to 3.4%. All advanced economies are forecast to grow 1.8% this year, vs. a 1.9% forecast in April's update, and an estimated 1.9% rate in 2015. The 2017 forecast was cut to 1.8%, from 2%.
Emerging and developing markets growth forecasts, however, were retained at 4.1% for 2016, and 4.6% next year. In 2015, growth was estimated at 4%.
With interest rates remaining low and negative in developed markets, central banks likely to become even more accommodative and the U.S. Federal Reserve expected to slow its rate-hike pace, investors are being forced to cast their nets wider to achieve returns.
“The tide is turning for emerging markets because Brexit increases the probability that developed market central bank stimulus will continue,” said James Barrineau, New York-based co-head of emerging markets debt relative at Schroders PLC. “As this stimulus continues, money flowing into emerging markets creates a virtuous cycle of increased foreign-exchange reserves, stable to appreciating currencies which lead to lower domestic interest rates, and consequently better growth prospects.”
“Brexit has, if you like, turbocharged the global search for yield and positive yielding assets,” said David Riley, head of credit strategy at BlueBay Asset Management LLP in London.
Pierre-Yves Bareau, managing director and emerging markets debt chief investment officer at JPMAM in London, said clients have returned to the market. “The past two or three years, nobody was talking to me about emerging markets. Brexit, I think, has finally triggered investment in emerging markets. ... Brexit has been ultimately a tailwind,” and the firm is seeing increased inflows “at this stage.”
Institutional inflows to dedicated emerging market equity funds tracked by EPFR Global totaled $1.7 billion for the week ended July 13, while $2.2 billion moved into bond strategies. For the week ended May 11, equity strategies saw net outflows of $1.6 billion — the biggest weekly outflow in 2016. Bond strategies recorded $301.8 million of net inflows.
But emerging markets are not just riding high on developed markets' woes. They had begun looking attractive even before the Brexit vote, sources said. After five years of disappointing performance, money managers are betting on a turning point for the battered markets and are starting to rebuild positions in both equities and bonds.