[Practical Finance] Beware of Exchange Rates and Butterfly Effects When Investing in 'Next China' India and Vietnam

Many Fund Products Only Hedge Won-Dollar
Volatility Between Local Currency and Dollar Must Also Be Considered
Investment May Flow Back to China if US-China Conflict Settles

Due to the de-Chinaization movement amid US-China conflicts, countries close to China or rich in resources such as Vietnam, India, and Indonesia?referred to as the 'Next China'?are gaining attention. In the financial investment market, Vietnam and India funds are attracting interest as alternative investment destinations instead of 'China funds.' However, rather than rushing to invest following trends, it is advisable to manage risks and consider these as diversification targets. Although the investment environment in these emerging countries is more favorable than in developed countries, volatility and uncertainty are also significant.

Risk management is necessary when investing in emerging market funds. Vietnam and India have rapidly risen as beneficiaries of accelerated de-Chinaization, but like two sides of the same coin, investment sentiment can reverse if US-China relations improve. While US-China conflicts present extreme scenarios affecting national security and economic sectors, both countries are also making efforts to improve relations, leaving the possibility of thawing open at any time.

Currency risk management is also essential. Even in currency-hedged products (which fix exchange rates in advance to guard against risks from exchange rate fluctuations), hedging is often done on the won-dollar pair rather than the won and the actual local currency, so fluctuations between the local currency and the dollar can still impact investments. Seonah Hwang, Branch Manager of KB Securities The First WM Branch, said, "The most important consideration when investing in emerging markets is the currency environment. During periods of a strong dollar, funds inevitably flow into the US, but currently, as US interest rate hikes are nearing their end, a weak dollar trend is observed, and with a mild recession atmosphere, the emerging market investment environment is expected to be favorable for the time being."

She also warned to be cautious of the 'butterfly effect' caused by fluctuations in the US economy. Branch Manager Hwang stated, "If signals emerge that the US recession is stronger than expected or if the dollar continues to strengthen or intensify, caution should be exercised in emerging market investments." This is because if funds remain longer or flow additionally into developed markets than expected, the capital flowing into emerging markets may decrease. Small volatility in developed markets can translate into significant volatility in emerging markets.

Preparation for political risks and institutional changes in emerging countries is also necessary. Changes in government policies, corruption, and unstable political environments can affect investment performance. Particularly, political situations and institutions influencing the investment environment in emerging countries can change rapidly, and due to low information accessibility, constant preparation for volatility is required. Additionally, reshoring?the phenomenon of domestic companies returning from overseas due to costs and other reasons?should be carefully monitored. Major countries such as the US, Japan, and Europe have increasingly decided to return to their home countries through supply chain restructuring after COVID-19.

Despite high growth potential, emerging markets have limitations for individual investors to invest with peace of mind. Restrictions on foreign ownership of listed stocks, high currency exchange costs, and low information accessibility pose obstacles to investment. Yongsoo Nam, Head of ETF Management at Korea Investment Trust Management, advised, "Rather than investing directly in stocks listed on the stock market, individual investors are recommended to invest indirectly through funds. Also, given the high growth potential, it is advisable to diversify investments or make staggered purchases to defend against volatility." Especially in emerging market investments, more cautious decision-making is necessary rather than overconfidence in investment performance or aggressive investments aiming for a 'big win.'

Meanwhile, the market expects the upward trend in the Vietnam and India stock markets to continue for some time. It is anticipated that foreign investors' interest will persist for a considerable period. Above all, the 'near-shoring' phenomenon?where many global companies that had entered China are relocating production facilities to neighboring countries outside China?is accelerating. There is great expectation that this change will lead to improved performance of companies in India and Vietnam. Increased investment by foreign companies aiming to benefit from near-shoring and the resulting currency appreciation in these countries also positively influence investment sentiment.

The Indian stock market is relatively less volatile among emerging markets. The recent three-year return of Indian funds is 80%, ranking first among global funds. The second is Vietnam funds (50%), and the third is US funds (36%), showing a significant gap. Therefore, many investors approach it with mid- to long-term returns in mind, such as through retirement pensions. The Vietnam stock market tends to be more volatile. Due to Vietnam's communist state characteristics, policy risks are constant, and the relatively small market capitalization leads to high stock market volatility. From early 2020 to early 2022, the Vietnam VN Index more than doubled but then experienced a rollercoaster ride with a drop of over 30%. Seonah Hwang of KB Securities The First WM Branch said, "Vietnam is ultimately a communist country, so the possibility of following China's path remains. We need to proceed carefully while closely monitoring reshoring and use China's experience as a learning effect."

This content was produced with the assistance of AI translation services.