Analysis: Counting the cost of currency risk in emerging bond markets

Fri Nov 22, 2013 9:55am EST
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By Sujata Rao

LONDON (Reuters) - Once a source of rich returns for yield-hungry investors, emerging markets are hammering home a long-ignored truism: banking on currency strength to enhance returns on stocks and bonds is not a one-way ticket to profits.

Currencies such as the rupiah and lira have slumped 10-20 percent this year as a seismic shift in global capital flows rattles even relatively robust markets, exacerbating international investors' losses on the underlying assets.

And as a long-term dollar uptrend gains momentum, fund managers are being forced to rethink their decade-long view of emerging currencies as an obviously strong bet.

That means having to start actively managing exchange rate risk - and the cost of hedging may well make the underlying investment look far less attractive.

So far this year, a strategy based on holding the lira, zloty, real, Mexican peso and rouble versus the euro, dollar and Swiss franc is losing 2.3 percent, Citi calculations show.

Returns on the same trade in 2012 were almost 9 percent while full-year returns have been negative only three times in the index's 12-year history, in 2002, 2011 and 2008.

"The volatility has been horrific on emerging currencies," Marino Valensise, CIO of Barings Asset Management told the Reuters Investment Outlook summit this week.

"We are perplexed by high volatility even on currencies such as Mexican peso which was brought down...for no reason."   Continued...

A money changer sells U.S. dollars to a customer in the border city of Hatay September 17, 2013. REUTERS/Umit Bektas