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Local currency EMD: A world of opportunity
Matthew Murphy CFA, CAIA, institutional portfolio manager, Eaton Vance
HEADWINDS TO TAILWINDS Local currency emerging markets debt (EMD) has witnessed a strong increase in investment inflows in 2019, with resurgent appetite for EM assets ushering in US$38bn in net allocations in the year to date. In con- trast, net flows stood at US$16bn in 2018. Performance, too, has bounced back. After declining 6.2% in 2018, the sector gained 2.9% on its main index, the JP Morgan Gov- ernment Bond Index – EM (GBI-EM) Global Diversified, in the first quarter. With inflows and performance up, that raises an obvious question: Can the recovery be sustained? In short, yes. We think so. The headwinds that buffeted local currency EMD through most of 2018 have abated. In this, the US Federal Reserve’s volte-face on further rate hikes has played a determinant role. So, too, has the US political establish- ment’s growing preoccupation with domes- tic rather than foreign affairs in the long run-up to the 2020 elections. Combined with comparatively hawkish EM central banks and expectations for benign inflation across much of the EMD universe we believe this will continue to support a positive outlook for local rates and curren- cies. In addition, pricing remains attractive for local currency EMD bonds, despite gains in the first quarter. Global macro risks could always reassert themselves, however, and fundamentals remain a concern in some key countries. Clearly, there is always the need for coun-
try-specific due diligence and careful evalu- ation of risks.
TIME TO GET SERIOUS In our opinion, Ukraine has particular rele- vance in illustrating the value of a country- focused approach. Specifically, we believe Ukraine, as a country, is often overlooked or underappreciated by the wider market. Ukraine is not a GBI-EM constituent and remains relatively small as a bond issuer. Yet, the country has grabbed headlines recently. In a rare instance of life imitating art, Volodymyr Zelensky, a comedian and TV personality who portrayed a teacher- turned-president on popular Ukrainian sit- com Servant of the People, was elected to the nation’s highest office on 21 April. Zelensky’s victory is more confidence boosting than comic. Like the TV character he portrays, Zelensky stands as a challenge to the status quo. He may represent the best chance to make meaningful inroads in the country’s fight against corruption. He is popular, reform-minded and has a strong mandate to govern. If he can lever- age these factors in the face of not insignif- icant challenges, there will be an opportu- nity to see real change in Ukraine. He takes the reins of an economy in the midst of recovery (GDP grew by 3.3% last year). After years of crisis, however, there is still significant scope for furthering reforms to help sustain and strengthen the economic turnaround.
In addition to the broad political and eco- nomic developments, as investors we view the currency and interest rate risk as appealing. In the first quarter, the Ukrainian hryvnia rose 1.3% against the US dollar thanks, in part, to the country’s com- paratively high real rates.
CONCLUSION Last year, Ukraine’s local currency debt returned 17.9%. Considering the extent of the GBI-EM’s decline, that is impressive. However, Ukraine was just one of several off-index markets to post double-digit returns in the sector, with Nigeria (11.2%), Kenya (15.4%), Egypt (17.0%) and Serbia (12.2%) all registering robust gains.¹ To access such opportunities, it is necessary to look beyond the benchmark. It is also necessary to combine deep research at the country level with fine-grain analysis of cur- rencies and interest rates. Only then, can one determine which countries and securi- ties/instruments present opportunity and which do not. While the overall market is doing well today and we maintain a positive outlook, it must be noted that as the EMD rally continues to mature, country analysis and selection will come to matter ever more.
1. Serbia return hedged vs EUR, all others vs USD.
Sources: JPMorgan, Eaton Vance, as at 31/3/2019. For Professional Clients/Institutional Investors use only. This material is presented for informational and illustrative purposes only and should not be construed as investment advice, a recommendation to purchase or sell specific instruments, or to adopt any particular investment strategy. It has been prepared on the basis of publicly available information, internally developed data and other third party sources believed to be reliable. Eaton Vance Management (International) Limited (“EVMI”) is not responsible for any subsequent investment advice given based on the information supplied. Past performance is not a reliable indicator of future results. This material is issued by EVMI who is authorised and regulated in the United Kingdom by the Financial Conduct Authority. Visit EVMI at
https://www.eatonvance.co.uk. JP Morgan Government Bond Index - Emerging Market (GBI-EM) Global Diversified is an unmanaged index of local-currency bonds with maturities of more than one year issued by emerging markets governments. Investing in Emerging Markets is sensitive to stock market volatility, adverse market, economic, political, regulatory, geopolitical and other conditions. Changes in exchange rates may lead to fluctuations in the value of investments. Debt securities are subject to risks that the issuer will not meet its payment obligations. Low rated or equivalent unrated debt securities of the type in which a portfolio will invest generally offer a higher return than higher rated debt securities, but also are subject to greater risks that the issuer will default. Unrated bonds are generally regarded as being speculative.
Issue 84 | May–June 2019 | portfolio institutional | 9
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