Investors mixed on how markets react to Trump

The election of Donald Trump late last year marred the long-awaited rebound in emerging markets, seen early in 2016 after years of underperformance.

But sources are split on the impact Mr. Trump will have on the U.S. government's relationship with various emerging markets countries — China and Russia in particular — and how it will affect institutional investors.

On one side, the potential for tariffs and trade wars has some consultants and money management executives cautious on the asset class. On the other, Mr. Trump's rhetoric toward Russia has brought the previously unloved country back onto the list of opportunities for investment.

The MSCI Emerging Markets index gained 11.2% in 2016, outstripping a return of 8.4% for the MSCI All-Countries World index. That compares with a 14.7% loss for the MSCI Emerging Markets index in 2015, while the MSCI ACWI returned -1.9%.

Emerging market equities valuations remain attractive, and fixed income is benefiting as inflation ticks down in some of the previously troubled countries, such as Brazil and Russia.

But even that is not enough to alleviate fears for these markets.

“What is holding us back from a broader communicated overweight that is really aggressive are two of the risks out there,” said Phillip R. Nelson, director of asset allocation at NEPC LLC, in Boston. Both, he said, are well known. “The more relevant to us is what's going on in China and policies in China. The general easing, ability for credit to grow, some of the stimulative policies out of the central bank and government in China is broadly supportive for emerging markets and China.”

Should that reverse, “it would raise some concern,” he said.

Mr. Nelson also warned that while the depreciation of the Chinese currency has been managed, any rapid depreciation would bring volatility to other Southeast Asia currencies. “That is not an insignificant risk in our minds.”

China also is a risk for David Morton, a partner and chief market strategist at Rocaton Investment Advisors LLC in Norwalk, Conn. “China is a worry — in the last 18 months (the government and central bank) have managed to create some stability, or seeming stability,” despite a weakening of the currency. “If volatility increases in Chinese markets and the economy, the rest of the world's financial economy may come under pressure. As for the last few years, China continues to be a big wildcard,” said Mr. Morton.

The second risk, which also involves China, is “more of a headline grabber but much more a tail risk and low-probability event,” said Mr. Nelson. That is, trade restrictions and trade policy disruptions coming out of the U.S. under Mr. Trump.

The threats Mr. Trump might pose to emerging markets are not going unnoticed by institutional investors. Mr. Nelson said the firm is receiving questions about Mr. Trump and the incoming administration from clients in the U.S.

Rupert Watson, head of asset allocation and a principal at Mercer Investments in London, said while investors are generally waiting to see what is proposed by the new administration, they are asking questions around whether Mr. Trump's policies are likely to trigger a trade war, and how much damage this would do to emerging markets. “All the dust hasn't even been thrown up in the air yet. ... Time will tell what policies he will pursue,” said Mr. Watson.

It seems these risks are not lost on institutional investors. Figures from EPFR Global show investors pulled about $7.2 billion from emerging market equities strategies in the month ended Dec. 28, and about $5 billion from emerging market debt strategies over the same period. That followed a year of net outflows from emerging market equities, but a year of net inflows for emerging market debt strategies.

The election of Mr. Trump in November led to an immediate sell-off in emerging market stocks and currencies, “as many investors feared ... (Mr. Trump) might follow through on campaign threats to dismantle trade agreements, build a wall on the U.S.-Mexico border and levy significant tariffs on imports from China,” said Richard Titherington, chief investment officer, emerging market and Asia Pacific equities, at J.P. Morgan Asset Management, based in Hong Kong.

The political agenda is not negative for all emerging markets, however, said Sergei Strigo, head of emerging markets debt management at Amundi in London. “It is going to create more differentiation between countries. Clearly Mexico has been singled out — we have seen significant underperformance of Mexico assets even this year already,” he said.

Also potentially under threat are those emerging market-based companies that depend on the U.S. for revenue. “From a macro standpoint, we view a somewhat more protectionist U.S. as a digestible event from an emerging market perspective,” said Salman Ahmed, London-based chief investment strategist at Lombard Odier Investment Management. “However, from a micro point of view, investors now need to pay more attention than ever to the individual companies they are gaining exposure to,” as a more protectionist policy could be disruptive. “For instance, companies listed in Taiwan and South Korea stand out as their reported sales figures point to a very high direct exposure to the U.S.”

But money managers said the election of Mr. Trump has also delivered some opportunities, particularly against the backdrop of rising oil prices.

“The market benefiting most from this is Russia,” said Peter Elam Hakansson, chief investment officer and partner at East Capital, based in Stockholm. He cited as positives for Russia its abundance of natural resources and dependency on these resources, “but also the possibility that Mr. Trump will view Russia regarding sanctions in a different way (than) the previous administration.”

A more sanguine approach to Russia was also cited by Wim-Hein Pals, head of emerging markets equities at Robeco in Rotterdam, the Netherlands. The firm is overweight Russia due to the potential for the relationship between Russia and the U.S. to improve, and strong earnings prices.

So far, Russia is being treated as the main beneficiary of Mr. Trump's election, added Mr. Strigo. Following a rally last year in emerging markets, “after the election everything sold off, and Russia didn't really. Going forward, we assume the same. It is not that negative for emerging markets, (but) there is certainly some political risk for some countries we will have to watch for."