Feature
Pummelled by market forces that were lit- tle to do with them, over the last year emerging markets produced returns that were unlikely to convince investors of their value. By the end of 2018, the Bloomberg Barclays index tracking un-hedged dollar-denomi- nated emerging market debt had lost more than 4%. Local currency index tracking debt fell more than 7% during the same period.
While US and European bond indices fared little better – having to cope with their own economic and political headwinds – these developed markets traditionally retain the confidence of institutional investors. According to State Street’s Bond Compass strategy outlook, in December “long-term investor holdings of local currency emerging market debt were… at a five-year low”. But why? There were no great upsets in Columbia or the Czech Republic, two of the group’s constituents, and Bra- zil’s new president, although not roundly welcomed by most of the international political left wing, was seen to be positive for business.
Plain and simple, it was the dollar.
The US currency, against which most of these markets peg their own monetary sys- tem, became too strong. Although many were firing on all cylinders, they were understandably unable to keep up with the world’s largest economy. But the story changed in December, when chair of the US Federal Reserve Jerome Powell decided to halt – or at least pause – interest rates hikes. According to State Street, in that month, flows to emerging market debt “jumped above their five-year median for the first time in eight months”.
And so they have continued, according to data monitor EPFR, with around $28bn (£21.1bn) in new money rushing into emerging market assets as a whole in the last three months of the year – making up almost the entire annual total.
The bounce-back has been quicker than the 2008 financial crisis, when, despite it being little to do with them, emerging markets saw tremendous, sustained outflows. Investors, it seems, are not turning and staying away from the sector.
“If you look at the risk-adjusted returns his- torically and respectively for emerging mar- kets, they are actually really attractive,” says Mark Fawcett, chief investment officer of NEST.
“They give you higher interest rates than you would have in developed markets and yet, with one or two notable exceptions, they are economies whose debt levels are lower, their trade deficits are low or possi- bly have trade surpluses.”
Trying to be too tactical
is really tough and it is just too easy to get it wrong. Mark Fawcett, NEST
IN VOGUE In Mercer’s 2018 European Asset Alloca- tion Survey, emerging market debt was the most popular non-traditional bond strategy for pension schemes. Some 18% of them said they had an allocation to the strategy, with an average 5% holding. The next clos- est was multi-asset credit, with 16% of funds disclosing an allocation. Peter Thompson, an independent trustee at Capital Cranfield and former chairman of the National Association of Pension Funds, says that the asset class has become more mainstream and much more accessible. “It might not be something for tiny pension funds, but it is a sensible option for mid-to large-sized schemes who are still on their journey to maturity,” he adds. The £30bn Brunel Pension Partnership is in the process of picking a manager for a £1.1bn emerging markets equities portfolio.
The fund, which has exposure to these nations’ debt through its multi-asset credit portfolio, sees the sector as one to grab with both hands. “Emerging markets will be the source of more than half of global eco- nomic growth over the next 10
NEST, the UK’s largest defined contribu- tion (DC) investor, takes a strategic approach to emerging markets. “Trying to be too tactical is really tough and it is just too easy to get it wrong,” Fawcett says. “Being strategic, but thinking about risks you want to take, is more important.” And increasingly, trustees of all types of institutional investor in developed markets are willing to take these risks. Dinesh Visavadia, trustee of the Action for Children Pension Fund, says he saw some great opportunities in emerging markets as 2019 got going.
“In 2018, many emerging market countries were doing well, it was their relationship with the dollar that mainly hurt them,” Visavadia says.
“The trade war did not help either. Funda- mentally, emerging markets are not poor – and their outlook is good,” he adds.
28 June–July 2019 portfolio institutional roundtable: Emerging market debt
years,” says Mark Mansley, Brunel Pension Partnership’s chief investment officer. “Undoubtedly there is great potential here for investment managers able to think long-term and find the best opportunities.” For NEST’s Fawcett, the comparison with developed markets makes emerging ones attractive.
“Debt levels in Japan, the US, UK and parts of Europe are massive – well over 100% to GDP in many cases,” he says. “This is not necessarily true of the emerging markets, so strategically they look pretty attractive.” On a risk-adjusted basis, NEST finds emerging market debt potentially more attractive than equities due to its lower vol- atility, Fawcett says. “We evaluate emerging market debt along- side high-yield bonds, and we are just going to private credit as well,” he adds. “We don’t try to time the market, we just want to
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