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Finding pockets of value in emerging market debt

Finding pockets of value in emerging market debt

Last year was a good year for emerging market debt (EMD), as synchronised global growth and falling inflation made for strong tailwinds.

But can 2018 maintain the bull market? Ricardo Adrogué, head of emerging markets debt at Barings, thinks so.

‘Inflation in emerging markets remains near 17-year lows and while we may begin to see upward pressure on the prices of some goods and services, we believe that emerging markets are generally well-positioned to handle this,’ he said.

‘The emerging markets local currency debt asset class has benefited from an environment characterised by strengthening EM currencies, falling interest rates and persistently low inflation.

‘While the healthy global economic growth picture may inevitably feed through to inflation in wages, commodities and other places, emerging markets are generally healthy enough to withstand such pressures and still offer, in our opinion, attractive potential returns for debt investors in the years to come.’

This tailwind is helping push EMD to new heights, especially with rising commodity prices helping prop up valuations says Helene Williamson, head of global emerging markets debt at First State Investments. This saw inflows into the sector hit a six year high, with more than $12 billion (£8.6 billion) pumped into local and hard currency EMD funds in 2017, according to Thomsons Reuters.

Williamson believes the reduction of new issuance in 2018 will be a positive for the asset class, providing another tailwind.

‘As the global backdrop remains agreeable, we would expect inflows to continue into 2018. From a supply point of view, net issuance from EM sovereigns is expected to be lower than in 2017, so we would anticipate a positive supply/demand balance for EM sovereigns. In quasi-sovereign issuers, we see improved financial metrics and a positive rating trend,’ she said.

Despite forecasting continued solid returns for emerging market debt market Williamson expects that valuations, which says were cheap in 2017, will start to look more full as the year progresses, albeit still more attractive than other parts of the fixed income universe.

‘EM valuations are less compelling than at the start of 2017, but in relative terms compared to other fixed income asset classes, spreads in EM in our opinion look attractive, particularly in an environment of rising commodity prices and improving fundamentals,’ she said.

‘The risk to our positive base case could come from a faster than expected rise in US inflation, which would lead to a more rapid rise in global rates. Given stretched valuations across a number of asset classes, such a repricing of global rates could dent the bullish market sentiment and risk appetite.’

South Africa's potential

That said, there remain pockets of EMD that remain ‘extremely’ attractive value for money, says Citywire A-rated Mirabaud Asset Management Emerging Market Bond fund Daniel Moreno.

This is largely due to the political situation, he says, which has been a negative for so long that the market has embedded a high degree of political risk premium into its government bond prices. But there are now signs that the outlook is improving, following the election of its new president, Cyril Ramphosa, in February.

‘The change happened quicker than most analysists would have predicted over the past few years and the new leader Cyril Ramphosa is expected to be pro-business. I think this is positive for the South African bond market which hasn’t had much in the way of positive new for many years now,’ he said.

‘It’s an opportunity for the country to re-establish its self as an investment destination and it could very well replicate the stark changes we saw from a pro-market government in Argentina a few years ago.’

His comments are echoed by Jan Dehn, head of research at Ashmore Group, who points to the possibility of reform in South Africa as one of the major bright spots for EMD in 2018.

‘The country needs reforms, new ideas, less corruption and a boost to business confidence. Ramaphosa has the potential to deliver all this. Ramaphosa’s rise to power in South Africa also illustrates another ‘truth’ about politics in EM countries, namely that EM presidents generally do not survive politically for very long if they start to mess with the economy,’ he said.

‘This is because the vast majority of people in EM countries are poor with no inflation hedges or unemployment benefits, that is, no means of protecting themselves against macroeconomic volatility. Therefore, they have a strong preference for stability and growth.’ 

 

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