ANNOUNCEMENT: Expert Investor is now PA Europe. Read more.

Riding the tumult in EM debt

It’s been a rough ride for emerging market debt this year but despite rising rates and surging volatility targeted exposure to certain markets may still be able to reap attractive rewards.

Riding the tumult in EM debt

The sell-off in emerging markets shows no sign of abating as the political stalemate in Italy panics markets.

It’s been a rough ride for EM debt this year as 10-year US Treasury yields rise and the US dollar strengthens. The JP Morgan Emerging Market Bond Index (EMBI) has fallen more than 4% since the start of April.

“It’s been fairly cataclysmic,” said Richard Hodges, Head of Unconstrained Fixed Income, Nomura Asset Management.

Nonetheless, most European fund selectors surveyed in Q1 2018 planned to hold or increase their investments in the asset class over the 12-month period to end March 2019, according to by Last Word Research.

Oil and Treasuries

“The driver of everything will be US bond yields,” Hodges continued. “If you call US bond markets correctly you call EM debt right.”

The yield on the benchmark 10-year Treasury note was lower on May 29 at about 2.8%, amid geopolitical jitters.

“If US Treasury yields go down significantly then government bond yields will be lower everywhere.”

Another factor is the price of crude oil which has rallied this year. Brent crude, the global benchmark, was trading at about US$76 on Tuesday – a rise of about 15% since January.

“The emerging market countries that look attractive export a of lot of oil and will benefit from the rise in crude prices,” Hodges said.

Leading emerging market exporters include Brazil and Columbia in Latin America and Indonesia and Malaysia in Southeast Asia.

Egypt and Argentina

Another overlooked bright spot may be Egypt, said Hodges. Standard & Poor’s upgraded the North African country’s credit rating from to B this month (from B-) following upgrades by other rating agencies on the back of economic growth and moderating inflation.

Ten-year Egyptian government bonds yields fell 11% to 14.2% in late-February before rising to 15.3% by late May.

“From my perspective there was no real reason why Egypt’s should suffer. Its currency is relatively stable. [The market sell-off] has created a great entry opportunity,” Hodges said.

Argentina, meanwhile, has seen investment pour into the country since the election of market-friendly President Mauricio Macri in 2015. It’s US dollar-denominated 100-year bonds issuance last year was heavily oversubscribed. But as the country grapples with high inflation and large trade and fiscal deficits Macri has opened talks with the IMF to help tackle its economic problems.

The Argentine peso has fallen 25% against the US dollar since the start of the year.

“It does not take much to drive emerging currencies weaker and that begins to form a vicious circle,” Hodge said. “But is has been overdone. By going to the IMF it should give Argentina some stability for their currency and their debt markets.”

However, David Roberts head of global fixed income at Liontrust remains unconvinced about the prospects for Latin America’s third largest economy.

“Some people seem to believe that Argentina calling in the IMF will end well but as we know that is often not the case. The IMF is notorious for demanding its pound of flesh,” he said.

Hope and expectation

Roberts said he expects the worst is yet to come regarding emerging market debt.

“The big hope for emerging markets at the moment is that the US doesn’t raise rates too fast, which is more a triumph of hope over expectation,” he said.

Seventy five percent of professional investors surveyed by NN Investment Partners in March said they expected fundamental economic drivers in the emerging market debt sector will improve over the next two to three years and as a result planned to increase allocations to the asset class over the next 12 months.

“For all the soothsayers saying emerging markets will be different this time because there is a better political balance and spread of risk if you look at the fundamentals you don’t have to probe too deep to be somewhat concerned,” Roberts said.

“Emerging markets have become incredibly expensive particularly in debt because there has been lot of money, especially from US mutual funds, chasing a bit of income. And now that we see US Treasuries paying close to 3% I think a lot of people are going to short emerging markets and buy US Treasuries.”

Hodges, however, said despite the risks from volatility and interest rate rises, targeted exposure to certain emerging markets – such as India, Indonesia, Argentina and Egypt – could reap attractive medium to long-term rewards.

“It depends on what your time horizon is,” he said. “If you’re looking for a return over the next three months you are going to have some measure of volatility. However, if you’re looking at where you are going to deliver returns over the next 12-18 months and how you are going to deliver them then I would suggest EM debt still represents a significant opportunity.”

  • Can M&A and buybacks breathe life into UK market?

    Can M&A and buybacks breathe life into UK market?

    Both buybacks and M&A should help realise value in UK shares, boosting prices and giving investors another reason to consider the UK stockmarket Not only does M&A activity appear to be picking up, with a high-profile bid for UK electronics retailer Currys, but the scale of company buybacks continues to accelerate. If it goes well,…

  • Capital Group launches multi-thematic Article 8 funds

    Capital Group launches multi-thematic Article 8 funds

    Capital Group has launched a set of multi-thematic sustainable funds that are available for investors in Europe, writes Christian Mayes. The Capital Group Sustainable Global Opportunities fund (LUX) will invest in global equities, while the Capital Group Sustainable Global Corporate Bond fund (LUX) will target fixed income exposure. The launch also includes a multi-asset offering…

  • Bond funds pull in €29.7bn in January – LSEG

    Bond funds pull in €29.7bn in January – LSEG

    Bond products were the best-selling asset class in January, according to LSEG Lipper’s European Fund Flow report, writes Christian Mayes. The asset class pulled in a net €29.7bn in the month, while Money Market USD grouping was the best-selling Lipper Classification after receiving €11.2bn inflows. Providers of mutual funds pulled in €22.5bn, while passives saw net…

  • Quarter of Article 8 funds at risk of greenwashing – MainStreet Partners

    Quarter of Article 8 funds at risk of greenwashing – MainStreet Partners

    A quarter of all Article 8 funds could be accused of greenwashing based on their sustainability framework and practices, according to MainStreet Partners, writes Christian Mayes The 24% of funds classified as a greenwashing risk by the 2024 ESG Barometer report marks a four percentage point increase from the 20% flagged at the end of…

  • EU green rules could stymie decarbonisation projects – ExxonMobil

    EU green rules could stymie decarbonisation projects – ExxonMobil

    The European Union’s climate regulations may lead to it halting its investments in Europe, ExxonMobil has warned. Speaking to the Financial Times, Karen McKee, president of the product solutions division, said the oil and gas giant had struggled to begin decarbonisation projects in Europe due to the regulatory burden. The result, she added, was that…

  • ICE flags need for Europe to double green investment

    ICE flags need for Europe to double green investment

    Investments to modernise energy and transport must double by the end of the decade to reach 2030 climate targets, the EU has been warned. According to the Institute for Climate Economics (ICE), which has released the European Climate Investment Deficit report, the bloc lacks what it calls a “consistent tool” to ensure monitoring of the…