Opportunities in emerging markets debt

Jonathan Boyd
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Opportunities in emerging markets debt

We see emerging markets (EM) as one of the more attractive opportunities in global fixed income at the moment. First, the pickup in global growth is supportive of global trade, and thus emerging markets. EM growth is increasing, and for the first time in five years, the spread between EM and developed market (DM) growth is widening, which historically has been positive for flows and EM currencies.

A number of EM countries, like Argentina and Brazil, have also pursued important reforms over the last few years. Average debt/GDP in EM is 47%, significantly lower than in DM. And EM currencies have depreciated significantly since the onset of the taper tantrum, leading to a substantial improvement in current account balances. We are mindful of the rally thus far, but with yields averaging 5-6%, we believe valuations are attractive relative to other fixed income opportunities, especially considering close to 60% of global fixed income trades with yields below 2%.

IDENTIFYING THE BEST OPPORTUNITIES WITHIN EMD

In our EMD strategies, we take a total return approach to take advantage of the broadest possible opportunity set – hard currency sovereigns, corporates, and local currency debt. In addition, we look to capture inflection points, whether driven by structural reforms, political change or improving growth dynamics, in order to capture the greatest risk/reward and minimize downside risk. We find that most gains are priced in before these events actually occur, so we look to adjust positioning in anticipation of the event.

We also find that credits the market may deem among the riskiest can present attractive opportunities because they are often forced by economic and political realities to shift to a more orthodox policy mix.

EMD IN A RISING RATE ENVIRONMENT

We believe the developed market monetary policy backdrop will remain benign. Rising US rates are less of a concern, given the gradual and well-communicated path of Fed policy. We also believe the European Central Bank remains very deliberate with its exit strategy, and the Bank of Japan will continue with yield curve targeting. As such, we prefer higher yielding markets in countries that are undergoing structural reforms. These investments provide spread cushion in a rising rates environment.

THE ‘RIGHT’ ALLOCATION TO EMD IN A GLOBAL FIXED INCOME PORTFOLIO

EMD now represents 16% of global fixed income. In other words, EMD has grown from a ‘core plus’ allocation to a standalone asset class. We have performed various efficient frontier analyses which indicate the optimal global fixed income portfolio over the test period (2003 through the end of 2016) would include at least 50% in EMD. We recognize that number is large and unrealistic in practice, but believe most institutional investors are significantly underweight even a neutral allocation and seem generally inclined to add on any sell-off. In addition, we continue to see new investors making strategic dedicated allocations to the asset class and expect this to continue as investors capitalize on the improving growth dynamics and attractive valuations.

 

 

This material is for general information purposes only and does not constitute an offer to sell, or a solicitation of an offer to buy, any security. TCW, its officers, directors, employees or clients may have positions in securities or investments mentioned in this publication, which positions may change at any time, without notice. While the information and statistical data contained herein are based on sources believed to be reliable, we do not represent that it is accurate and should not be relied on as such or be the basis for an investment decision. The information contained herein may include preliminary information and/or “forward-looking statements.” Due to numerous factors, actual events may differ substantially from those presented. TCW assumes no duty to update any forward-looking statements or opinions in this document. Any opinions expressed herein are current only as of the time made and are subject to change without notice. Past performance is no guarantee of future results. © 2017 TCW