AS we come to a turbulent end of 2016, a challenging yet hopeful 2017 outlook characterizes the emerging markets (EM) world. With economic growth rates being revised higher for the US and stabilization in China, this would typically compel us to eagerly revise up our EM forecasts, but this time however we are apprehensive, driven by the fear of a possible de-globalized environment. For investors looking at the EM as a possible investment destination for 2017, they will have to differentiate the risk here. There will be those EM countries that will and have benefited from a stabilized commodity environment. These countries will see their economic growth rates push higher next year. And even if energy prices do not rebound aggressively, the macro adjustment that has been undertaken by energy exporting countries should bode well in 2017. On the other hand, there will be those economies that have grown on the back of globalized trade, some friction seem unavoidable in the coming years as the US turns more inward. Longer-term economies with large, young population could be in a position to generate robust domestic demand even if external demand disappoints. Some of the Asian countries in this context would be clear winners. If the US moves away from multilateral initiatives, even if temporarily, there will be scope for China to reach out to EM economies, both by firming up trade agreements and strengthening FDI offers. Greater inter-regional trade could accelerate in this context. We are with the opinion that greater selectively would be key in choosing which EM countries will be winners and therefore do not recommend the so-called "passive-beta" approach to EM investing. If anything, it would mean more active management could outperform in the EM space in 2017. Other factors that will also dictate EM asset prices will be the development of US benchmark yields and its effect on portfolio flows into the USD. Remember that excessive USD appreciation hurts EM local currency exposure and has recently been the major driver of volatility among EM investments. One cannot deny the very appealing valuations that EM exposed investors find themselves with, providing quite compelling risk adjusted returns. However investors will have to understand that valuations can remain cheap over a long period of time if market sentiments remain poor. As an asset class, EM equities are still under-owned by the majority of global investors which should provide some support on further weakness. With their economies having much improved balance sheets with debt- GDP a third of the levels in the developed world. Hence, there are positive fundamentals that can drive higher returns from EM investments in 2017, but they will also be filled with indiscriminate risks as well. We are with the opinion that over the longer term, the positives will outweigh the negatives. Investors should therefore keep a watchful eye, as any pressure on EM asset prices could provide an opportune time to add to their portfolios. * The writer is the Managing Director, Head of Advisory SEDCO Capital
