Cover story – EM Debt
dynamic asset allocation across emerging market asset classes is an important return lever for those seeking exposure to emerging markets,” Bisat adds.
In short, investors should not get bogged down by talk of an emerging market debt crisis. In this way, high quality emerging market assets should be a core part of a portfolio. “Emerging markets is a wide-ranging asset class with ample high-quality names that may offer yield pickups to their developed market comparators,” Bisat adds. And despite the wave of sovereign defaults, they have not caused contagion, caused other emerging markets to “default like dom- inos”, says Smith. In fact, he says: “Most emerging markets, especially those with investment-grade credit ratings, are in a much stronger position than they were in previous decades. They tend to borrow at home, rather than in hard currency, and have substantial foreign exchange reserves to buffer shocks.” This is extremely positive for emerging markets investors. Another reason for a more optimistic outlook on the asset class, despite the lurking debt crisis scenario, is that the major- ity of emerging markets have reached the end of their mone- tary policy tightening cycles.
A forecast substantial decline in headline inflation over the sec- ond half of the year should allow emerging market central banks to slowly commence their easing cycles. And fundamen- tals for the asset class have been fairly stable since the Covid-19 pandemic, particularly amongst lower-rated issuers.
Market debate
Another issue within the debate is often confusion about what constitutes the emerging markets asset class. This raises the question whether the term emerging markets is in fact redun- dant. To highlight this point, the official grouping from index providers, such as MSCI, contain a hotchpotch of countries from across the globe which often have little in common. A striking change since the financial crisis of 2009 has been
The days where one invested in emerging markets as a
‘raw beta’ play are gone. Amer Bisat, Blackrock
the rise, in index terms at least, of the two emerging market giants: China and India.
China to 29% from 17% and India to 14% from 6%. The big- gest losers have been Brazil (16% to 5%), South Africa (8% to 3%) and, of course, Russia (6% to zero).
This means that the famous acronym of ‘BRICS’ is pretty worthless as an assessment of emerging market potential given there are now only two left standing. Although it is safe to say that Brazil’s President Lula is trying to change that. Whatever the travails in China, its economy has at least been relatively stable and growing steadily, Covid lockdowns aside. But the makeup of its stock market has been transformed. In the case of India, its growth has been much more uniform. History also has some lessons to teach investors when it comes to emerging markets. The central point is that it is vital to stick to countries which are well governed and avoid those which are not.
Emerging market vices Aubrey Capital Management has been following this trend with interest. Those that cannot control “their vices, usually inflation, rampant corruption, or both,” are doomed to remain “peripheral players, even if their populations and demograph- ics suggest otherwise,” says Rob Brewis investment manager at Aubrey. Turkey is a case in point. The country was, and potentially remains, huge: a decade ago it was 2% of the benchmark and growing. Yet today it is 0.6%, and that is only after last year’s Ukraine driven bounce – given it was a rare winner from the conflict. Turkey has also voted “to continue its decline,” according to Brewis, with the re-election of Recep Tayyip Erdogan as presi- dent. Russia, much of Africa and parts of Latin America remain locked in this same cycle, he says. Furthermore, emerging markets are no longer driven by com- modities, Brewis says, and are now “arguably inversely” corre- lated to them. Good news as commodities and inflation subside.
Another factor in the picture is that today’s major emerging markets are considerably more resilient thanks to a better mix of industries: more domestic consumer driven, less commodity and export driven.
In addition, while balance sheets and returns are stable, it appears, Brewis says, that “cashflow is much stronger than it was in the past”, which is good news as it means the next phase of growth can be more easily financed in most emerging mar- kets. This offers a positive outlook – and one again far removed from a debt crisis.
Another factor is how developed market events continue to have an impact on emerging markets, according to analysis undertaken by Franklin Templeton. Although this trend is
18 | portfolio institutional | July-August 2023 | Issue 125
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