London/Lagos: The term “emerging markets" can conjure up the image of a homogeneous asset class that sits nicely on one rung of the risk ladder. Nothing could be further from the truth.

As the tide of US monetary stimulus recedes, it’s becoming clearer who’s swimming naked. On the one end are nations with the promise of rapid growth and increasingly open economies. On the other are political tinderboxes that hold investors hostage to their power-grab dramas.

In between are the also-rans, with spiraling debt burdens, volatile inflation and crummy trade accounts to boot. These three categories have been treated as one investable pool in the era of Federal Reserve support, but as capital becomes scarcer, it may no longer be wise to gloss over the discrepancies between them.

“There has not been much differentiation in recent years," says Kenny Tjan, who helps oversee $17 billion as investment director at Value Partners Asset Management Singapore. “Investors just looked for exposure to emerging markets so that they don’t miss out on the rally. Next year, the overall performance may not be as good. The catalyst would have to come from looking for differentiation."

The axe of tighter monetary policy will fall on all emerging-market currencies, but the deepest cuts may be suffered by those that nurse wounds of their own making. Money managers call these idiosyncratic risks— the key to asset allocation when markets aren’t swayed by global macro forces.

Here’s a run-down of the key differentiators:

Politics

The risk that domestic and international rows can derail investor gains has worsened in 12 of the top 20 emerging markets this year, according to Bloomberg political-score indexes. Money managers don’t sell every time there’s an election, leadership scandal or street protest. They press the panic button only when the noise affects policy making, threatens private property or undermines central-bank independence.

Turkish President Recep Tayyip Erdogan’s renewed outbursts against higher interest rates and the power struggle in South Africa’s ruling party are cases in point. Other risks:

Inflation

Real yields for investors are set to rise in many emerging markets. Bloomberg forecasts for inflation this year and the next suggest India, Indonesia, Malaysia and Latin America may witness a widening gap between nominal rates and price growth.

However, prices may rise faster in China, Russia and Brazil, shrinking real yields. Returns may even turn negative in Chile, like they already have in Turkey.

Monetary policy

Eight of the 20 economies may see inflation accelerating next year, according to Bloomberg forecasts. The ability of central banks to increase interest rates could determine money managers’ interest in them.

Russia comes out the worst by this parameter, because economists expect a rebound in inflation, but the central bank may continue its dovish stance because of the stalled economic recovery.

Societe Generale SA says the bulk of currency returns in 2018 will have to come from carry trades, which meaning policy makers will have to bear in mind higher US yields when adjusting their own borrowing costs.

Trade

Improving external balances have largely been an Asian story. While the continent leverages its status as the world’s manufacturing hub, some other emerging markets aren’t that strong.

Across Latin America, current-account deficits may widen over the next three years, according to economists’ forecasts. Turkey has the biggest shortfall in the developing world. South Africa’s deficit is stabilizing but is still above 3% of its gross domestic product.

The health of external balances may receive greater attention next year as higher US interest rates make it harder for governments to raise cheaper funds or refinance their debt.

Reserves

A stronger dollar means some emerging-market central banks may have to dip into their foreign-exchange reserves to curb currency volatility.

Debt

A surge in borrowing has exposed China to the threat of a financial crisis, where the country has about $3 of debt for every dollar it produces. The debt-to-GDP ratio is projected to soar to 327% in 2022 from 259 percent in 2016.

Fiscal balances in emerging markets have deteriorated on average since 2013 and may prove to be a source of vulnerability in select markets, according to JPMorgan Chase & Co.

As for external borrowing, debt-to-equity ratios are rising in most of Latin America, emerging Europe and Africa. Bloomberg

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