Emerging market, the key is a flexible investment approach

Calich (M&G): “It is important to have the ability to move between these sub-asset classes and choose the best ideas within the universe”

“A flexible investment approach remains key when investing in the emerging bond markets, given that the dispersion of returns between hard and local currency-denominated bonds and sovereigns and corporates is much higher than in the past”. The speaker is Claudia Calich, manager of the M&G Emerging Markets Bond Fund, who believes that it is therefore important to have the ability to move between these sub-asset classes and choose the best ideas within the universe.

What is your view on the emerging markets?
For the rest of the year, I see returns consolidating at a slower pace than so far over the year to date. Still, the asset class is providing yields on the range of 6-7% on average, so even if the price return slows going forward, there is still the prospect of the carry return. In terms of the economic outlook, I believe that some of the larger economies will finally start bottoming out in terms of growth. The IMF recently released its updated World Economic Outlook and, for the first time in a long while, it has not materially lowered its forecasts for emerging market (EM) growth.

Which are the best and the worst emerging markets, and why?
Against some of the ongoing key challenges in the asset class, I believe there will be winners and losers among EM bond issuers. For example, while oil exporters lose from cheaper prices, oil importers may gain from such lower costs. As a result, my preferred allocations in the fund include both government and corporate issuers among oil- and commodity-importing countries, with examples in Asia that include India and Indonesia, as well as eastern Europe on a selective basis. In addition, my investment activity earlier this year included adding exposure to oil-exporting plays such as Azerbaijan and local currency Russian sovereigns on the view that oil prices had bottomed in the low US$30s and that assets in these countries were attractively valued if there was a price rebound.
In Latin America, I participated in Argentina’s recent return to the sovereign new issues market, believing it represented an attractive investment proposition (see below). Among other larger markets in the region, I would note that Mexico’s sustained fiscal deficit and the collapse in the oil price are adversely affecting its economy, while Moody’s recently downgraded its outlook on the country. On the other hand, however, lower oil prices led to a depreciation of the peso that is positive for export-oriented Mexican companies, some of which particularly benefit from the relative strength of the US economy. In Brazil, I still have concerns about the outlook for the country given the extent of its political and economic problems. ?Elsewhere, my favoured investment themes include holding exposure to select smaller markets in Central America and the Caribbean that have strong ties to the US economy. Relevantly, for example, certain countries should gain from increased remittances from their citizens based in the US who are employed in its robust labour market. Partly based on these considerations, the fund holds sovereign bond positions in Honduras, Guatemala and the Dominican Republic.

Could you focus on one or two of these countries, which risks and opportunities do you see?
In Eastern Europe, I believe some markets should benefit indirectly from the European Central Bank’s (ECB) recent expansion of economic stimulus measures, which have included further cuts in interest rates. The ECB’s policies have pushed yields lower in the euro area, in turn attracting investors to these neighbouring markets. I have recently invested in government bonds from Romania, for example, based on their higher yields relative to government bonds from other eastern European countries, as well as compared to developed European markets.
I have a favourable view on Argentina and its recently issued sovereign bonds on a number of counts. The move helps to normalise the country’s financial relations with international markets and should also help to increase its foreign exchange reserves, which had fallen worryingly after being excluded from markets for some years. Looking ahead, Argentina seems on course to deliver positive reform momentum, managing its economy with more orthodox policies and continuing to improve its relations with the West.

What do you think about emerging markets bonds? It’s better to invest in local or hard currency and in which countries? And vs high yield?
I believe that determining the right asset allocation between government and corporate issues denominated in local and hard currencies, together with careful country and security selection, are key factors for successfully investing in the asset class. Importantly, I am unrestricted in allocating the fund’s assets between local currency-denominated EM sovereign debt, hard currency EM sovereign debt, and hard currency EM corporate debt. I split the portfolio between these sub-asset classes and blend high-conviction macro calls with fundamental credit analysis. In doing so, I actively manage three levers that drive the fund’s performance, namely credit risk, duration sensitivity and currency positioning. The outcome is that I allocate the fund’s assets to those areas where I see the best relative value and avoid exposure to those emerging market bonds and currencies whose outlook I do not like. Indeed, avoiding the worst-performing issuers and/or defaulters is critical at this point of the cycle.

About M&G Emerging Markets Bond, how is it positioned and how is it going?
The fund is a diversified global emerging market bond fund with allocations across the sovereign and corporate markets. As at the end of April 2016, around 45% of the fund was invested in hard currency EM sovereigns, with 23% in local currency sovereigns and 32% in hard currency EM corporates.