The best returns occur when things transition from terrible to bad. Samy Muaddi, T. Rowe Price


strategic ambition that we could benefit from currencies appreci- ating over the longer term. Alan Pickering: Over the years, the dilemma that I as a trustee have had is whether to split particular asset classes geographically or not. Fashion has ebbed and flowed over the years. On occasions, schemes have wanted to invest in an asset class without imposing too many geographical constraints, while at other points in the evolution of different schemes they have been willing to compart- mentalise asset allocation by type and region. Most defined benefit schemes I am involved with are moving closer to risk transfer from the employer to an insurer. As they do that, they are looking for income generators with a fair degree of liquidity. We are in a lower for longer environment and those deploying income seeking asset classes on our behalf are being en- couraged to look worldwide but through a lens which has an ESG flavour to it as well. That can be a challenge in certain markets.


PI: What classes of emerging market debt are you favouring during this pandemic? Muaddi: Our bias has been towards hard currency debt. In theory, currencies should appreciate from productivity gains, collapsing inflation differentials and central bank independence but that has not played out.


Statistics support this argument. If you take hard currency emerg- ing market debt in sterling terms, since 1993 you would have gener- ated a return of 9.3% per year, which compounds to around 980%. The return from local currency-denominated equities would have been 5.75% per annum. When you compound that there is a cumulative difference of 630%.


The bond side outperformed the stock side, which is atypical for countries. Hard currency emerging market bonds have outper- formed local currency-denominated emerging market stocks in about two-thirds of rolling three-year periods.


Philosophically, we like our assets managed by managers who think carefully about dynamically altering the level of risk they take depending on the opportunities available. So, they put their foot on the accelerator if they are getting well rewarded for risk and hit the break if everything is expensive.


That is particularly salient in emerging market local currency debt, which is a volatile asset class where you can get unduly hurt by currency fluctuations.


Over time we have heard some managers say that we are in for some short-term noise, but the parameters of the fund do not al- low us to protect capital for you. We explicitly sought an approach that when managers needed to defend capital they have the levers to do so and when the opportunity presents itself they are mentally geared to take advantage.


One of the reasons we are in local currency debt is because of the


Currency depreciation has been a release valve for countries as they have gone through the necessary growing pains of managing external pressure. We do not see that changing. So, our bias is towards hard currency debt to compound interest. More specifically, our more nuanced contrarian view is that a core approach to emerging markets should include corporate assets. When you dig into the data, the corporate market’s composition is significantly more defensive and allows for better interest compounding. Lasocki: We still look favourably on soft currency debt. At some point the multi-year US dollar bull-run must end. Some US assets are behaving slightly different than we might have expected a few years ago.


It is important to remember that the currency effect may wipe out these attractive returns. This year some of the biggest losers in the local currency debt space were countries with solid, high single- digit returns which were wiped out by double-digit currency loss-


November 2020 portfolio institutional roundtable: Emerging market debt 9


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