Don't Panic: Why Downside Protection Is So Powerful for Emerging Markets Investments
To state the obvious, emerging market equities are risky. Investors are exposed to extreme levels of unpredictability due to elevated levels of political, currency, and liquidity risk. However, there’s another, little known risk that accompanies this asset class: It routinely experiences large drawdowns.
Given this, investors should be interested in how their emerging market investments respond to drawdowns. There are two benefits from strategies that offer downside protection. First, they allow investors to be less panicked when such drawdowns occur, which helps them stay invested. Second, and more important, such strategies may produce strong relative returns. By helping preserve capital in drawdown periods, they allow investors to participate more fully in any ensuing rally.
This paper takes a brief look at historical drawdown data and how downside protection may help mitigate this risk for emerging market investors.