William Blair: Recent currency headwinds lifting on emerging markets
William Blair sees a significant investment opportunity across the global currency landscape and is beginning to increase risk positions in emerging currency exposures.
Visiting Australia from London this month, William Blair partner, currency expert, and Dynamic Allocation Strategies (DAS) portfolio manager, Thomas Clarke, said that a number of emerging market currencies – including the Brazilian real, Indian rupee, Indonesian rupiah, Malaysian ringgit, Chinese yuan, South African rand, and Russian ruble – are considerably undervalued.
“These currencies therefore represent a currency valuation opportunity and it is an opportunity that has grown in magnitude since the middle of 2015,” Mr Clarke said. “However, William Blair’s investment process means that before we act on this ‘where to invest’ opportunity we take a long hard look at our ‘why’. In this case, the why involves understanding why the huge value/price discrepancies have opened up.”
Mr Clarke said there are two reasons, one of which is that the valuation opportunity, while seemingly wide, is actually quite concentrated.
“Almost universally we see emerging currencies attractive and developed currencies unattractive,” he said. “If there were an even spread of attractive and unattractive emerging market currencies, and an even spread of attractive and unattractive developed market currencies, for example, the valuation opportunity would be more diverse. As it is, the opportunity is simply not compelling enough.”
The other reason is that significant non-valuation headwinds, including William Blair’s macro themes and geopolitical risks, are currently pushing against the pull of valuation itself.
“For instance, our commodity super-cycle macro theme hurts the currencies of commodity exporters such as Brazil, South Africa, and Russia,” he said. “Our external financing vulnerability theme hurts currencies of countries with large balance of payment deficits, slow or negative growth, and/or problematic governance, including the fundamentally attractive Turkish lira, Brazilian real, South African rand, and Colombian peso. Slowing growth in China represents a headwind for Asian emerging market currencies, which would otherwise be very attractive.”
On the issue of geopolitical risks, Mr Clarke said several currently favour developed market currencies over emerging. “Geopolitical risks in the Ukraine and the Middle East, as analyzed through our game theoretical framework, point to near-term headwinds for some emerging market currencies,” he said.
Mr Clarke said that while there are some positives when it comes to macro themes and geopolitical risks in the emerging world (Asian commodity importers being one example), in general the ‘why’ influence is predominately negative for emerging market currencies.
“In fact, the ‘where’ and ‘why’ parts of our investment process have largely been working in opposition since mid-2015,” he said. “This compels us to be cautious about the opportunities identified by our fundamental valuation analysis. However, commodities have recently stabilised under official guidance, and market participants appear to be less punishing towards the externally vulnerable currencies. Hence we are partly rebuilding several emergency currency exposures. China’s flip from last year’s small yuan devaluation to supportive intervention last quarter also reduces the influence of another macro-thematic headwind.”
