Valentina Chen, fund manager, Aviva Investors emerging markets local currency bond fund, agrees. “The countries who are holding elections this year will not want to do anything difficult. I think though that overall investors will have to readjust their expectations and realise that going forward they will not be able to get the returns they have been used to over the past few years. The focus now should be on those countries that have the strongest long-term macro stories.”
Allan Conway, co-head of emerging markets debt relative return at Schroders, also believes that investors should drill down further. “The country decision, which has always been important when investing in global emerging markets and is one of our explicit alpha drivers, is likely to become even more important in the period ahead.”
For example, he adds, if you look at the impact of tapering, countries such as India, Brazil, South Africa, Indonesia and Turkey experienced a sharp sell-off but they represent only 30% of the MSCI Emerging Markets index. “On the other hand, those countries running large current account surpluses such as China, Korea, Taiwan and Russia were unaffected and represent 50% of the index.”
Mixed fortunes
Greenberg also advocates breaking down emerging markets into segments. “There are countries such as India, South Africa, Brazil and Turkey who will be challenged by elections and tapering due to their large current account deficits and reliance on external funding but there will also be those such as China who will not be as impacted. The Third Plenum marked acceleration in the pace of market reform and new premier, Xi Xinping, is seen to have the political power to push these reforms through although it is not a done deal.”
Jian Shi Cortesi, manager of the JB Asia Focus Fund at Swiss & Global is also optimistic about the country’s prospects despite the slowdown in growth. “China’s credit-driven economic growth model is unsustainable, but the world’s second largest economy is evolving as it moves away from an overreliance on investment towards increased consumption,” says Cortesi.
“The new reform packages included 60 initiatives which are to be implemented over the next 10 years. This ambitious plan will enable China to embark on a new growth path through promoting a market driven economy, supporting private businesses, increasing consumption and importantly building trust in the new government.”
New opportunities
In terms of sectors, Shi Cortesi notes, that the “MSCI China Index has an overrepresentation of China’s ‘old economy’ with 70% of its constituents comprising telecommunications, energy and financial companies. Many of these companies are mature, state owned and slow-growing industries with significant policy headwinds. The best opportunities exist in emerging fast-growing industries benefiting from favourable government policy such as consumer, technology, healthcare and clean energy.”
Bartosz Pawlowski, global head of EM strategy at BNP Paribas also believes there will be more relative-value opportunities as countries emerge from the crisis at different speeds in the FX and fixed income space. “The idea of buying ‘good’ and selling ‘bad’ emerging markets is the wrong way to think about cross-EM FX trades due to the negative carry often associated with these trades, as well as their exposure to risk sentiment. Looking at the delta on the macro fundamentals of emerging markets is key. We have identified Poland, Israel, the Czech Republic, Korea and Singapore as the countries that are likely to benefit most if growth is sustained.”
The general consensus is that local currency bonds are a better bet than the dollar denominated international bonds typically favoured by global investors. “Yields in developed markets are still much lower than historical averages with US five-year government bonds trading near 1.55%,” says Jan Dehn, head of research at the Ashmore Group, an asset manager which specialises in emerging markets. “This is in contrast to local currency bonds which are trading near 6.8% with the same duration.”
Kaan Nazli senior economist, emerging markets debt team at Neuberger Berman, favours local currency debt due to recent real yield rises making them less vulnerable to a sell-off in Treasuries and improving their relative value to hard currency debt. “I also think that when the Fed does start to taper it will be less of a shock than when it was first announced in May,” he says.
“The appointment of Janet Yellen as the new chairman has given people more confidence because she is very employment focused.” Market participants also believe the launch of Bank of America Merrill Lynch’s emerging market local currency corporate bond indices – the first of their kind – will give the asset class a boost. Many developing countries already have large local bond markets denominated in domestic currencies, which companies tap to raise financing.
However, global investors have been concerned over their liquidity and tradability. Dehn believes this is a significant development because “the vast majority of the world’s institutional investors only recognise asset classes if they have indices. The BAML index is imperfect – it only represents 5% of the universe of local currency corporate debt – but its existence enables investors to tap into what could eventually become a $30trn asset class.”
“There is a great deal of pressure for these countries to reform but there are elections being held everywhere next year, most notably in Indonesia, Turkey, India, Brazil and South Africa. This will delay any changes and is not constructive for emerging markets.”
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