Navigating Emerging Markets & the Lure of Crypto

Introduction

Investors seeking above average returns are perpetually interested in new products &/or markets.?This may consist of a new Exchange Traded Funds (ETF) or a digital asset such as Cryptocurrency.?As a basic principle, Institutional Fund Managers aiming for Alpha (α) seek a diversified portfolio with non-correlated returns.?This is why Insurance Linked Securities make for an attractive portfolio proposition due to the fact that the instrument is not correlated to traditional market returns.?In this article ‘Emerging Markets’, a phrase that was coined more than 20 years ago, will be explored in terms of its vast potential and pitfalls.?Finally, the article will conclude by analysing the key broking and underwriting considerations from an insurance perspective.

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Emerging Markets

The term denotes economies which have surpassed the development phase but not yet reached a developed economic output.?Currently, this includes countries such as Brazil, Mexico, India and Russia.?China was once named as an emerging economy but has since exceeded this phase by a considerable margin.?The political and economic stability of Emerging Markets have a distinct correlation with the investment opportunity, which will now be examined.

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Upside

By its very nature emerging markets have a degree of volatility, which some investors may view as a hallmark of opportunity.?For retail investors, ETFs can provide exposure to several emerging countries in one fund.?Derivatively, an investor can gain exposure to Emerging Markets when investing into global companies, such as Apple or Coca Cola.?Therefore, Emerging Markets provide a crucial diversification opportunity, the potential of doing business at lower transaction costs and an opportunity for higher than expected returns.

At the time of writing Nubank, a digital lender, is expected to list in New York and raise $2.5bn with a market capitalisation of $41.1bn. Their service includes credit cards, savings accounts, loans and insurance. This type of listing shows the potential of investing into an Emerging Market; Nubank could even eclipse Brazil's biggest conventional bank.

Risks

From an investment perspective there are several risks which must be analysed and pro-actively risk managed.?The overriding political stability and potential legal restrictions of an Emerging Market can exacerbate the financial risks.?These financial risks include liquidity risk, cash flow risk and foreign exchange risk.?Non-standard statistical variance and potential market inefficiencies can cause pricing to vary from its ‘true’ value.?Moreover, a key issue in emerging economies is that there may be lack of access to hedging instruments for volatility in capital flows which makes it more difficult to counteract foreign influence.

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Broking & Underwriting Considerations

When brokers and underwriters consider Emerging Markets they must analyse similar factors.?This means that an underwriter must understand the macro environment and the political stability of the territory.?Ergo, a Financial Institutions underwriter may take comfort in the event that the business hedges some of the risk through Political and Credit Insurance.?The legal framework and specific culture of the country where business is carried out should be carefully scrutinised.?When insuring a foreign territory caution must be exercised insofar that different countries may have a different legal definition of the same word.?Local laws may require insurance to be placed in the home jurisdiction as a fronting arrangement with reinsurance provided elsewhere.?A recurring issue in Emerging Markets insurance persists when the value of the Sum Insured is inadequate and leads to Underinsurance.??Furthermore, in terms of monetary considerations the cashflow and financial statements of the company can reveal whether the business relies heavily on sovereign debt in international markets or local sovereign market debt.?In tandem with the financial statements, an understanding of the motivation of local creditors in particular, will give significant insight into the potential bankruptcy exposure; every Professional Lines underwriter should be scrutinising this carefully.

Conclusion

In the author’s opinion emerging markets offer a potential opportunity for investors and insurers alike.?However, caution must be taken as there are many factors that must be analysed as the socio-political and economic environment of an Emerging Market can be very different to that of Europe or North America.

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ABOUT THE AUTHOR

Daniel Lim (IMC, FCII Chartered) is a qualified risk and insurance practitioner with over 15 years experience in the London and International market. He has serviced a number of high profile clients including several notable PLCs but is also passionate about adding value to smaller businesses. He has a keen interest in finance and all topics related to risk management.

Daniel can be contacted on [email protected] or via the LinkedIn URL.

DISCLAIMER?

The contents of this article do not constitute advice in any capacity whatsoever and are provided for general information purposes only.?

There is no responsibility from the author for any information contained within this article.

The author excludes any liability in respect of the contents or for action taken based on this information.

This article does not necessarily reflect the views of an employer (past present or future), or any other institution affiliated with the author.