Emerging markets are not all alike


By Enzo Puntillo, manager of the JB Emerging Markets Opportunities Bond Fund at GAM

“Many investors currently view emerging markets as one allocation, but substantial divergence in macroeconomic developments is creating a myriad of fixed income opportunities. Investors should resist the temptation to oversimplify the emerging market universe or risk missing out on potential opportunities from individual countries going through different stages in their respective business cycles.

“One of the key reasons for the divergence lies in the desynchronised credit cycles among both emerging and developed countries in the years since the financial crisis. Desynchronized credit cycles have created diverging economic cycles and monetary policies, with huge implications for interest rates, credit spreads and currency movements across the emerging world.

“This divergence can be clearly seen in the progress of external rebalancing. Eastern European countries are most advanced in this respect, with credit flowing back into their economies, benefiting growth over the long term. Chile is also making good progress, with its current account balance now close to zero as a result of successfully reducing imports. This is particularly noteworthy as the country has had to overcome the headwind of lower commodity prices.
“Countries that have failed to make progress in rebalancing their economies include Peru and Colombia. Both are running sizeable current account deficits that are only deteriorating further. Brazil has made some progress, although its current account has benefited to some extent from the weaker currency. The outlook is positive for the currencies of Poland, Hungary, the Czech Republic, India, Mexico and Chile where growth should return. Investors should remain cautious on Brazil, Peru and Colombia.

“On the fixed income side, Brazilian local currency bonds are the most attractive of the local markets, with nominal yields of around 13-14%. Even after accounting for inflation at around 8.5%, real yields are compelling. In addition, inflation is expected to come down to around 6% next year, with the central bank having scope to cut interest rates over the next 12 months due to weak economic momentum.

“Mexico is proving interesting as the market has overpriced the expectation for a normalisation in interest rates in the US. Real yields on 5-year bonds are at 2.5%, which is attractive both in absolute terms as well as relative to global peers.

“Areas to avoid include local currency bond markets in Eastern Europe, particularly Poland. This market is among the most expensive in the emerging region, buoyed by the country’s strong economy and a sharp drop in rates in sympathy with the ECB’s monetary loosening policy. Hard currency bonds in the region, for example in Hungary and Croatia, are more attractive. These offer much better value than their local currency peers.”