M&G bond vigilante: The ‘rare’ emerging market that we love

Last July the manager warned that markets were “smoking crack”, because prices on emerging markets suggested they were being regarded as a ‘safe haven’ to avoid the debt crisis in developed markets.

In fact emerging markets always have and likely always will rely heavily on global capital flows that tend to be cyclical in nature, the manager believes.

This view was confirmed in the second half of last year when emerging markets tanked amid the global downturn in market sentiment.

However, the manager has now said that falls in the Mexican peso make the country now look like a “rare” attractive emerging market, in an extensive entry on the M&G Bond Vigilantes blog.

“The EM countries that are particularly exposed to these global capital flows are the ones running large current account deficits, since by definition countries running current account deficits are reliant on capital inflows from abroad to fund themselves,” he said. “A ‘sudden stop’ or reversal in these capital flows leaves these countries very vulnerable.”

He said this dynamic was apparent in the second half of last year, with several emerging economies with large current account deficits seeing their currencies tank. Among these was the Mexican peso, Mr Riddell said.

“In fact the Mexican Peso was hammered in 2007-08 too. The peso’s high beta characteristics probably owe something to it being one of the most liquid emerging markets, but whatever the reason the Mexican peso is looking very cheap to us,” he said.

“And it’s not just the currency that looks attractive – in a world of negative real yields, Mexican real yields stand out as being huge.”

He said Mexican core inflation stood at 3.3 per cent year-on-year, while 10 year nominal Mexican local currency bonds, or Mbonos, were yielding more than 6 per cent.

“These high real yields aren’t because of any concerns regarding credit risk, since Mexico is one of the best quality EM debt issuers – Mexico is actually also considered a developed market, having been admitted to the widely followed Citigroup World Government Bond Index in October 2010,” said Mr Riddell.

“We like Mexico, and were buyers of Mexican local currency bonds earlier this year.”

He said a recent research trip to Mexico City had reaffirmed these views, but also highlighted political, monetary policy and drug-related problems.

“Overall, the high yields on offer in Mexico more than justify the risks in my opinion, with the caveat as mentioned at the beginning that Mexican assets are subject to global capital flows like any other EM asset,” he said.

“On this point, though, it’s interesting to note that Brazil’s changing IOF tax policies on bond holdings is encouraging all those yield chasing ‘Mrs Watanabes’ in Japan to look at Mexico as a carry trade alternative to Brazil in the region.