What Your Consultant Is Saying About...Egypt

(February 1, 2011) — Mounting unrest in Egypt has sent ripples of worry throughout global markets, with investors fearful that the crisis could have a contagion effect on the emerging market world. Yet, investment consultants are indicating to their clients that despite the current crisis in the Middle East, investors must take a longer-term approach, viewing the crisis as a natural evolution while placing greater emphasis on county-risk.

The continuing situation in Egypt has raised a red flag for institutional investors in that they must become more aware of the issue of sovereign debt, according to Cynthia Steer, managing director of investment strategy at Russell Investments. “Conflict within emerging markets in the Middle East is part of a natural evolution,” she tells aiCIO, noting that the strife puts a spotlight on the need for institutional investors to transition from focusing on asset allocation to focusing on country-risk. “This crisis is reflective of the fact that we, as institutional investors, need to move faster in understanding this.”

Matt Stroud, a member of Towers Watson Investment’s Global Investment Committee, responsible for the firm’s views on the economy and markets, says that while Towers Watson Investment has taken a more cautious approach to emerging markets with the recent issues in Egypt, he hasn’t witnessed a noticeable difference in regards to his clients voicing heightened concern about further turmoil in emerging markets. The concern, he explains, has been more focused on emerging equity market valuations after a strong run in 2010 not adequately discounting the heightened political risks investors face relative to developed markets. “The perceived comfort with developed market relative to emerging market equities in the current environment may be dominated by the broad sense that the economies in the developed world are improving and developed world equity markets look to us to be around fair value, with the global economy set to grow in 2011 as well,” he says. “We’re keeping our eyes wide open in regard to the situation in Egypt, looking to see if it takes a turn toward more violence, and certainly the picture could change, but so far clients are anticipating good economic activity and equity returns within expectations.” He adds: “To address potential worries, Towers Watson Investment would want to make sure we understood whether client fears stem from something specific in regards to Egypt, such as a spike in the price of certain commodities like oil, or whether it stems from something broader, such as geopolitical risk.”

Stroud’s comments are reflective of the general position among many investment consultants that potential client concern would likely be a result of broader worries about the volatility of equity markets worldwide as opposed to worries directly focused on Egypt, with its relatively small, anemic economy. “Egypt doesn’t have much direct exposure for our clients given the modest size of its economy and its capital markets – with the lack of Egypt’s economic success possibly being a driver of popular unrest in the first place,” Stroud says.

Adam Tosh, managing director of investment solutions at Rogerscasey, agrees. With Egypt representing such a small percentage of the MSCI Emerging Markets Index for equities, clients with a broadly diversified plan need not be concerned, while investors with a more Middle East and North Africa (MENA) focus may need to have a more serious conversation with their portfolio managers on how to handle risk, he notes. Furthermore, according to Tosh, a positive effect of the unrest in Egypt could be the possibility that the quick-money going into the emerging market sector, creating a bubble-like environment, may hiccup temporarily, allowing valuations to stabilize or fall — a benefit to long-term emerging market investors.

“We won’t expect a knock-on effect from Egypt impacting Eastern Europe or Asia,” Tosh indicates. “I’d be more concerned about regional knock-on effects. I’m not saying don’t ignore it. But put it in the right context.”