Your IndustryMay 19 2014

Emerging Market Debt - May 2014

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Approx.60min

    Emerging Market Debt - May 2014

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      CPD
      Approx.60min
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      Introduction

      By Nyree Stewart
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      This led to concerns regarding the current account deficits of various countries and, in turn, the term ‘fragile five’ was coined to describe the precarious positions of Turkey, Indonesia, India, South Africa and Brazil.

      While these five countries had little in common aside from a widening current account deficit, the increased attention did lead to drastic policy measures, including Turkey’s interest rate hike to 12 per cent from 7.75 per cent in January this year.

      So 12 months on, what impact have these policies and the actual implementation of tapering had on emerging market debt? Is the picture still as bleak as some would argue?

      Robert Simpson, portfolio manager in the emerging market debt team at Insight Investment, notes that emerging market assets have enjoyed a long period of sustained outperformance since the acute phase of the financial crisis.

      But he adds: “That came to an abrupt stop last year in Ben Bernanke’s speech and we saw a very sharp sell-off in emerging market assets, particularly local currency instruments and foreign exchange.

      “That dominated the [investment] flows from about May and through 2013, and coming into 2014 there was an expectation that trade would continue.”

      However, he points out that since the start of the year the market has seen “relatively well-behaved US Treasury markets, with the 10-year Treasury yield below 260 basis points (bps). Coupled with that, you’ve seen an improvement in policymaking within some emerging market countries and therefore you’ve seen a recovery in emerging market assets since January/February this year through to now.”

      He adds that the asset class is now much better supported than it was in the past year, and this has resulted in better-than-expected performance for the year to date.

      Simon Lue-Fong, head of the emerging debt team at Pictet Asset Management, notes that following Mr Bernanke’s testimony last May, emerging market dollar spreads over US Treasuries moved from roughly 260bps to 375bps, so the spread widened very sharply.

      But almost a year later, he notes: “Out of hard [dollar-denominated EM debt] and local [currency EM debt], hard has performed much better. Now we are about 30bps in spread terms from one year ago, with spreads now roughly 290bps, compared with 260bps. They have had a remarkable recovery. It is almost as if quantitative easing tapering never happened.”

      On the flipside local currency EM debt has had a rougher ride and a slower recovery, but does this suggest more opportunities to find a good investment?

      Mr Lue-Fong explains: “If US Treasuries are no longer moving up on tapering fears, then perhaps the risk premia drops out. If that happens it means people are comfortable with emerging market risk, which then means emerging market currencies stabilise, interest rates can be cut again and you can make money on both the rates and the currency.”

      After a horrendous 12 months, it seems there may yet be signs of life in the emerging market debt space, providing you understand what to look for.

      Nyree Stewart is features editor at Investment Adviser