InvestmentsMay 19 2014

Expect diverse returns in emerging debt markets

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One key theme to note ahead of investing in the asset class is the differentiation that has occurred between emerging market (EM) countries in recent years.

In the words of MFS Investment Management: “When considering the opportunity in EM debt, we believe it is important to recognise that the asset class is not a monolith but rather a diverse mix of credits with widely varying risk and reward prospects.

“Thus it makes sense to think in terms of owning specific EM countries that offer good fundamentals at attractive prices; not about owning the asset class as a whole.”

According to MFS, the underperformance of emerging market debt last year left spreads at levels that still provide “attractive carry”.

Robert Simpson, portfolio manager in the emerging market debt team at Insight Investment, explains: “There is a huge difference across emerging markets depending on where you look in the world, whether that’s geographically or the various sub asset classes. So going forward the opportunities will be very differentiated across emerging markets.”

Mr Simpson reassures investors that, contrary to some opinions, emerging markets have not been through a “crisis” but rather a correction in prices and there remains attractive opportunities.

“We think Mexico as a country is improving. It has done a lot of positive reforms and we believe the compound outlook for Mexican assets is strong.”

Morgan Stanley dubbed South Africa, Turkey, Brazil, India and Indonesia the ‘fragile five’, as these countries have in common high and rising current account deficits, making them more dependent on foreign capital flows. “We believe there is still room for recovery in some of the ‘fragile five’,” adds Mr Simpson, “where the sell-off was overdone and we’ve seen an improvement in policymaking, particularly in places like Indonesia and India.”

Neuberger Berman launched an emerging market debt team in May last year and has since brought five funds to market within this space, including a hard currency, local currency, corporate debt, short duration and a blend fund.

The launch is indicative of the types of opportunities the asset manager believes are open to investors.

Rob Drijkoningen, head of the emerging market debt team at Neuberger Berman, observes: “From a top-down perspective it’s very clear that due to the sell-off we saw last year, [emerging market debt] way underperformed developed market equivalent credit asset classes.”

But there are countries to avoid. The situation in Russia is causing enough uncertainty for fund managers to remain wary. Ratings agency Standard & Poor’s announced on April 25 that it had downgraded its foreign currency ratings on Russia to BBB-/A-3 from BBB/A-2 following “large financial outflows” in the first quarter of 2014. It warned that the “tense geopolitical situation” between Russia and Ukraine could prompt further outflows.

For Sergio Trigo-Paz, head of the emerging markets fixed income team at BlackRock, the opportunities lie in the different dynamics between even neighbouring countries, such as Poland and Hungary.

He adds: “You can have different dynamics between commodity importers and manufacturers in emerging Asia, so investors can play many themes and many different opportunities, whereas in the rest of the world right now there is no dispersion.”

Ellie Duncan is deputy features editor at Investment Adviser