It is not enough to take a narrow look at “Greece” or “Europe” exposure without exploring the various risk factors and knock-on effects associated with it – it’s impact on liquidity, volatility, growth and so on. One of the more likely secondary effects the European crisis will be on certain emerging markets investments. Bank for International Settlements data show a heavy dependence on European banks for lending in these markets; emerging Europe (Poland, Hungary and Romania in particular) shows the greatest vulnerability to capital flight, with Latin America and Asia significantly less so. European banks will be responding to the crisis and to higher capital requirements (targeted for mid-2012) by further deleveraging. The first stop likely will be to shed assets that have the greatest impact on capital requirements, namely emerging markets. The effect is two-fold – a contraction in lending in these markets may depress growth while the sale of foreign assets will depress asset prices in those countries, both of which could hurt liquidity and cause volatility to rise.
While we are positive about long-term prospects in the emerging and frontier markets and will seek to capture that element of global growth in portfolios, we are currently not fully funded there. This benefitted clients during the sharp selloff in 2011 and we believe will continue to be advantageous as the Europe crisis plays out. We have positioned the bulk of our emerging markets exposure through managers that are either reasonably well hedged or who invest in high quality, growing companies that are conservatively capitalized or are entirely self-financed. Another focus is on companies that benefit from the growth of the emerging middle class (domestic demand driven) in these countries, rather than the more vulnerable export sector. We believe these elements, combined, make for a safer way to invest in markets that remain a strong long-term growth engine of the world.
This is an excerpt from our article “Natural Selection” published March 13, 2012