It’s well understood that emerging-market countries are volatile, but the short-term reversion patterns are less well recognized. That is to say, a given emerging-market country can be a conquering hero one moment, outperforming all other emerging-market countries, only to seemingly overnight become the goat, underperforming the broad universe dramatically. A vivid demonstration: Argentina’s equity markets over the past two years.
A South American saga
Argentina has had a fraught history, with multiple bouts of economic collapse, military dictatorships, and social turmoil. These include two defaults on its sovereign debt, the nationalization of a number of its largest private companies, and, in the late 2000s, the introduction of a restrictive regime of capital and currency controls. This last move proved to be the last straw for MSCI, which downgraded Argentina’s status from emerging to frontier in 2009, effectively removing it from most emerging-market portfolios.
After the downgrade, the government continued its retreat from the global capital markets, including a particularly contentious battle with owners of its defaulted sovereign bonds. The country’s onerous capital controls (investors were required to deposit 30% of incoming funds in an interest-free bank account for one year) made foreign ownership of its equities all but impossible, and those investors still interested in gaining Argentine exposure were consigned to the American Depository Receipt market.
The turnaround: reforming Argentina’s capital markets
Starting at the end of 2015, the longtime ruling party was unexpectedly voted out of office, and the new government moved swiftly to reach an accommodation with its creditors, resolving a series of court challenges in quick order, closing out this chapter of its financial history. It also began to aggressively unwind its capital and currency controls, signaling a deep desire to reignite trade and allow foreign ownership of its stocks. Investor reaction was equally swift, with Argentine equity markets exploding in 2017, outpacing the bulk of emerging- and frontier-market countries with an eye-popping 73.4% return—beating the emerging-markets index by over 36%.
As 2018 dawned, a number of prominent investors touted Argentina as one of the hottest prospects for the year, with many speculating that MSCI would welcome Argentina back to emerging-market status in its June review. However, this proved entirely too optimistic: In May, Argentina once again faced a full-blown currency crisis.
The reversion: Argentina’s latest currency crisis
Argentina’s central bank was forced to sell hard-currency reserves and raise interest rates to 40% to support the value of the peso. Ultimately the country’s government appealed to the International Monetary Fund for an emergency loan to protect its finances against the expected inflationary pressures and economic slowdown spurred by this collapse in the peso’s value.
Argentine pesos per US dollar
As a consequence, by the end of May, Argentina’s equity markets (as measured by the MSCI Argentina Index) had dropped 29.8% on a year-to-date basis, and its excess returns trailed the MSCI Emerging Markets Index by over 27%.
Excess return of MSCI Argentina vs. MSCI Emerging Markets Index
The bottom line
Emerging-market countries can change from winners to losers in very quick order. By staying broadly diversified, investors can avoid having their portfolio overly influenced by either a hero or a goat. In addition, by selling out of countries experiencing relative strength and investing in countries experiencing relative weakness, investors can further benefit from this pattern of reversion in emerging-market country returns.
Why Downside Protection is So Powerful for Emerging Markets (EM) Investments
EM equities are risky, with elevated levels of political, currency and liquidity risk. Did you know that they also routinely experience large drawdowns? Every calendar year since 2001, this market drop has exceeded 10% even in strongly bullish years. Now that is volatility!
Potential Parametric solution
Our Emerging Markets Strategy is designed to provide all-cap exposure to countries with the potential to outperform the index, with less volatility. Our investment process is based on mathematical principles of diversification, compounded growth, and volatility capture.
Tim Atwill, PhD, CFA, Head of Investment Strategy (emeritus)
Mr. Atwill leads the Investment Strategy team at Parametric, which is responsible for all aspects of Parametric’s investment strategies. In addition, he holds investment responsibilities for Parametric’s emerging market and international equity strategies, as well as shared responsibility for the firm’s commodity strategy.
The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss.