Currency Pain Hits Emerging Market ETFs

January 13, 2016

China has been dominating the headlines in the first several trading sessions of 2016, but it’s not the only emerging market making waves. On Monday, South Africa was big news after the country’s currency briefly fell by a whopping 9% on day.

In fact, all across emerging markets, stocks and currencies have been plunging this year, a continuation of a strong trend that began in earnest last year.

China The Epicenter

The Vanguard FTSE Emerging Markets ETF (VWO | C-86) shed 15.8% in 2015, and it’s already down another 8.2% in the first seven trading sessions of 2016.

China, of course, is the biggest deal when it comes to emerging markets. The country makes up 28% of the FTSE Emerging Markets Index that VWO tracks, and has seen a stunning drop in its stock market this year. (Last year, Vanguard announced it would be adding mainland China A-shares to its holdings, making it the first of the broad-based emerging market ETFs to do so.)

Along with economic slowdown concerns, rapid depreciation in China's currency, the yuan, has weighed on investor sentiment.

According to Brian Jacobsen, chief portfolio strategist at Wells Fargo Funds Management, people are viewing the decline in the yuan as a last-ditch "act of desperation to prop up exports"―a view he disagrees with.

Nevertheless, this bearish view has been ruling the day so far in 2016, leading to a 13.7% drop in the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR | F-61) on a year-to-date basis.

YTD Returns For VWO, ASHR

The Currency Impact
ASHR's decline exceeds that of local Chinese shares denominated in yuan. The difference can be attributed to the depreciation of China's currency, which reduces returns for dollar-denominated investors.

Indeed, this currency impact is one that's hampered returns for emerging market ETFs across the board, exacerbating losses for foreign investors in emerging markets.

Nowhere is this phenomenon more salient than in South Africa, where the country's currency―the rand―has fallen by more than 8.5% against the U.S. dollar already this year.

South African stocks have done just as poorly, losing 6.9% based on the MSCI South Africa Index. But for U.S. investors in the iShares MSCI South Africa ETF (EZA | B-98), losses are nearly double that, at 13.8%, due to the negative movement in the rand.

South Africa, which has struggled amid the bust in commodities such as platinum and palladium, makes up a significant chunk of the broad-based VWO, with a 7.3% weighting.

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