Investors warn of unseen risks in emerging markets

Reuters: Investors are becoming wary of emerging market assets despite their status as one of the last vestiges of yield in a low interest rate environment.

Speaking at the Morningstar Investment Conference in Chicago on Thursday, money managers said investors’ expectations for economic growth and investment return in emerging markets are too high relative to risks.

“People have grossly underestimated the risks in the emerging markets,” said Richard Bernstein, chief executive of Richard Bernstein Advisors LLC, a sub-adviser of Eaton Vance Management.

Bernstein said that earnings estimates for emerging market companies are overly optimistic and that emerging market countries are prone to inflation. He cited Turkey as an example.

Turkish Central Bank Governor Erdem Basci said on Wednesday that the nation’s inflation rate will rise in June and July due to base effects.

Emerging market countries also are vulnerable to a bubble or overpricing of China’s real estate market, said James Montier, a member of GMO LLC’s asset allocation team. The risks of a bubble extend to cement producers such as Mexico and Thailand as well as Brazil, given its commodity exports to China, Montier said.

“We have real concerns about the fundamental risk embedded in emerging markets,” Montier said.

Global stimulus measures such as the Bank of Japan’s commitment to inject $1.4 trillion into the nation’s economy in less than two years will also “spell trouble” for emerging market bonds, said Gibson Smith, chief investment officer of fixed income at Janus Capital Group. Janus managed $164 billion in assets at the end of March.

Some investors have said that the act of currency devaluation, which the Bank of Japan has done to its yen currency as a result of its stimulus, weakens the competitive advantage of neighbouring countries.

The profits in emerging market debt have also already been made, said Stephen Smith, managing director and portfolio manager for Brandywine Global Investment Management’s global fixed-income strategies.

He cited trade deficits in emerging market nations such as Brazil and Indonesia as warning signs. The Brazilian economy’s trade surplus flipped to a $ 6.2 billion deficit in the first four months of 2013, Brazil’s statistics agency showed.

“You really have to be careful when looking at the emerging markets,” Smith said.