Feature


Of all the asset classes into which investors sink their money emerging markets possess the most romance. They tell stories of adventure and of goldrush fortunes being made during never-to- be-seen again windows of opportunity.


All this building for a golden future is powered by debt, so the case for lending money to sovereigns and corporates in the emerging world is being pushed hard. At the heart of the sales pitch are the potentially high returns on offer from countries with strong fun- damentals and envious outlooks.


Indeed, growth projections in these markets were the stuff of dreams for investors based in the developed world. At the start of the year, emerging nations were driving 60% of global GDP, ac- cording to the International Monetary Fund (IMF). This was dou- ble the level in 1980 and further improvements were forecast. In- deed, emerging economies were expected to grow 5.2% this year, up from 4.8% in 2019, while developed market GDP growth was projected to dip to 3.3% from 3.5% in 12 months. This is one side of the coin. On the reverse are concerns over coun- tries descending into civil disorder and defaulting on their debts. Negative headlines about Lebanon, Venezuela, Peru and Argentina only reinforce this view. But emerging markets are also home to South Korea, India, China, the UAE and Chile where the funda- mentals have proved attractive enough to lure mature final salary pension schemes away from the perceived safety of the developed world’s depressed interest rates and yields. One such investor is Border to Coast, a local government retire- ment scheme pool. It has £2.7bn tied-up in such debt, while another local authority pool, LGPS Central, has lent £900m to emerging market sovereigns and corporates. Centrica Pension Schemes also have an interest here. Around 8% of its portfolio is invested in this asset class, the result of its de-risking strategy. Higher returns, diversification, low yields in developed markets… whatever the reason for holding these assets, international inves- tors have built emerging market debt into a $23trn (£17.8trn) universe. But when Covid-19 took hold at the beginning of this year, every- thing changed. Some emerging market nations were hit hard, such as India reporting almost 100,000 deaths from more than 6.3 million infections, at the time of writing. Brazil, Russia and Colombia were not far behind.


Declines in tourism and commodity prices piled further pressure on government finances and investors turned bearish. Indeed, pri- vate capital flows into emerging markets slumped to -$230bn (-£177bn) in May from more than $50bn (£38.5bn) just five months earlier, the National Bureau of Economic Research says. Fitch Rat- ings predicting a wave of sovereign defaults this year did not improve the mood.


A little wave Debt issuance across emerging markets had already jumped 20 November 2020 portfolio institutional roundtable: Emerging market debt


sharply with the average debt-to-GDP ratio rising to 59% from 36% in the five years to 2019 and is now expected to reach 63% this year, the World Bank says. While this is significantly lower than the levels found across advanced economies, emerging markets face higher debt servic- ing costs, particularly if their credit rating declines. And in many cases, they have.


Emerging market sovereigns have experienced 71 downgrades so far in 2020. But this may not be as bad as it sounds. Many of these were assigned at the height of the crisis between March and May and there is little sign of the wave of defaults that we were told to expect this year considering the level of downgrades. Indeed, despite some bonds trading at distressed levels, such as those issued by Angola and Nigeria, only Argentina, Ecuador, Leb- anon and Suriname have defaulted so far in 2020 and they were in trouble before the pandemic hit. In March, the first default in Leb- anon’s history, for example, was nothing to do with Covid as a cur- rency crisis forced the new government chose between re-paying its debts or providing basic services to its citizens. Four could soon become five as Zambia’s creditors rejected a plea to defer repayments until April next year. The previous emerging market sovereign default record was three in 2017, but five could hardly be described as a wave unless there is a flurry of defaults in December.


It is hard to imagine meaningful, sustained higher yields in the developed world.


Uday Patnaik, Legal & General Investment Management


Page 1  |  Page 2  |  Page 3  |  Page 4  |  Page 5  |  Page 6  |  Page 7  |  Page 8  |  Page 9  |  Page 10  |  Page 11  |  Page 12  |  Page 13  |  Page 14  |  Page 15  |  Page 16  |  Page 17  |  Page 18  |  Page 19  |  Page 20  |  Page 21  |  Page 22  |  Page 23  |  Page 24