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Best to Hedge Dollar Bets in Emerging Markets -- Barrons.com

4 Feb 2017 7:11 am
By Dimitra DeFotis 

Emerging Markets

President Donald Trump has declared that a weak dollar wouldn't be such a bad thing for the U.S. Greenback weakness also would be good, in theory, for emerging markets, especially countries that use their currency to make dollar-bond payments. Unfortunately, there are lots of reasons to believe the dollar could strengthen. A border adjustment tax on imports that exempts exports, for example, would tend to lift the dollar, as would more U.S. infrastructure spending. If the Federal Reserve raises rates, investors will be drawn to U.S. assets. That, too, would raise the dollar.

"That is where we stand: waiting for clarity on the policy framework before we have more conviction," says Gerardo Rodriguez, a co-manager of the $207 million-in-assets BlackRock Total Emerging Markets Fund (ticker: BEEAX). He and co-manager Jeff Shen oversee an asset mix that is 60% stocks and 40% bonds. Because they can hedge on currency, Rodriguez and Shen are able to buy and sell despite uncertainties.

After grading countries' dollar sensitivity and overall financial health, they have an overweight position in U.S.-dollar denominated bonds in Chile and Poland, where issuers have strong credit ratings and the wherewithal to repay debt. The managers are underweight debt in Argentina and Turkey because the countries' ratings reflect lingering default risk.

THE BLACKROCK DUO favor Indonesian and Russian stocks for their cheap valuations and accelerating growth. Central banks in both countries, but especially Indonesia, have room to ease monetary policy. They are underweight Mexico and Korea. In contrast, Mexico's central bank may continue to lift rates to try to bolster its weak currency. The Korean market is expensive and doesn't offer enough of a risk premium to account for recent political and corporate disruptions, Rodriguez notes. The fund's stock holdings have traditionally been dominated by technology and financial-services investments, but the managers remain underweight each, and overweight basic materials, energy, and communication services.

There are three main factors that make a country less sensitive to the dollar, and therefore more attractive to the BlackRock managers: 1) A small current account deficit, 2) high domestic savings, which signal less need for foreign borrowing to finance growth, and 3) a low level of foreign debt to gross domestic product. Combined, these factors put Asia and, to a lesser extent, Europe, in better stead than many countries in Latin America.

Over the past 12 months, the BlackRock fund produced a stock-like total return of 23%; the A shares carry a 5.25% load and 1.2% in expenses. The iShares MSCI Emerging Markets exchange-traded fund (EEM) soared 26% in the same time period with a 0.7% fee, while the iShares JPMorgan Emerging Markets Bond ETF (EMB) rose 12% with a 0.4% fee.

What ultimately weighs on the dollar, and therefore emerging-market assets, is policy, not random comments from politicians, Brown Brothers Harriman global head of currency strategy Marc Chandler said in a recent note. He warned that a Trump administration border-adjustment tax would be "disastrous protectionism." But protectionism is likely to produce winners and losers and volatility, which is great for active managers, Rodriguez argues.

For more on the dollar, see the Jan. 21 Emerging Markets column, "Playing Emerging Market Bond Funds in 2017."

Email: dimitra.defotis@barrons.com

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(END) Dow Jones Newswires

February 04, 2017 02:11 ET (07:11 GMT)

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