The Short View: The mindless chasing of returns

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Developments both political and financial in the Middle East do not seem to be deterring emerging markets investors, even though there has been an ugly correction for many Gulf region stock markets, which intensified this week. Saudi Arabia is off 9.5 per cent for the year, while Qatar is down 14 per cent, and Dubai by 34 per cent, for example. However, money continues to pour into the broader emerging markets, which continue to respond with strong price performance.

Some unfashionable commodity-rich Latin American countries have become stars. In Peru, for example, in spite of great political uncertainty, the Lima selective index is up 44 per cent this year.

The enthusiasm with which investment dollars are being poured into the asset class is disquieting. According to Emerging Portfolio Fund Research of Boston, which tracks international funds worth $5,000bn, there has been an inflow of $24bn to emerging markets this year. This compares with $20.3bn for the whole of last year, which was a record. Meanwhile, funds investing in the US, Japan and Europe have taken in a combined $13.4bn in three months. As many emerging markets started 2006 at record highs, this looks more like mindless chasing of returns than a rational attempt to look for value.

EPFR also found that most of the new money has gone into Bric (Brazil, Russia, India and China) funds. All these markets are up this year – Russia by 38 per cent, the Bombay Stock Exchange by more than 20 per cent, and China’s Shenzhen and Shanghai exchanges, which missed out on the party last year, by 18 and 24 per cent respectively. It remains unclear whether there are advantages in treating these economies as a group, or whether returns might be helped by adding more of the stronger emerging economies – notably Mexico, South Africa, South Korea, or Turkey.

This week’s events in the Middle East could be critical. A natural response to the Iranian nuclear crisis and a collapse of share prices in the region would be to rethink the risk premium for emerging markets. Fund flow figures for this month should provide interesting reading.

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