Susan: Hi, I'm Susan Gim, an Investment Portfolio Manager. And I'm joined by Ally Reynolds, a Portfolio Manager on the Global Emerging Markets team. This difficult quarter globally for investment markets has been driven by significant U.S. fixed income weakness and emerging markets were not immune.
From a relative return standpoint our funds underperformed in the quarter. Ally, can you help us understand the key drivers?
Ally: Yeah sure, Susan. Although the markets were negative, from a relative perspective, the two main drivers were Russia and U.S. interest rates. We were underweight Russia on concerns about military hostility, but we still held other Eastern European investments.
The surprising scale of the Russian invasion impacted all our Eastern European investments. So, we lost some relative ground there. Now, we also got impacted by rising U.S. interest rates. The biggest impact here has been on stocks with direct ties to both U.S. interest rates and the U.S. dollar.
We can see this in the broad-based strength of Middle Eastern markets over the quarter and they have both a dollar currency peg and a high proportion of banks and energy companies in the index. These markets gained in the region of 20%* over the quarter and whilst we had some exposure to the region, it was nonetheless a bit less than our benchmark overall. Rising interest rates have also negatively impacted high growth stocks globally and in emerging markets. We have an exposure to a handful of high growth digital economy stocks, and these suffered over the quarter as well.
Susan: Thanks Ally. The underperformance of growth stocks is part of a broader style rotation from growth to value that's been pronounced in emerging markets, and this rotation has been in place since late 2020. What is your take on this?
Ally: Well, it's interesting, Susan, because emerging markets offer high exposure both to long-term growth sectors as well as deep value commodity sectors. This means that a growth-to-value shift, like we've seen, can have a meaningful impact on performance outcomes.
The combination of supply disruption, emergency policy stimulus and the re-opening of economies has resulted in commodity-driven inflation. And that's been great in the short-term for value stocks. But these conditions are unlikely to last, as high commodity prices and rising interest rates are likely to break the up-cycle and send investors back in search of less volatile earnings streams. That's ultimately why we believe a combination of earnings, quality and growth will win out over the longer term.
Susan: Thank you Ally, appreciate your time going through the first quarter. Just wanted to let everyone know that we will have an upcoming podcast that will go into further detail on our digital economy holdings.
Ultimately, we believe a combination of earnings, quality and growth will win out over the longer term.