Capital Ideas^TM

The market seems very positive on the global backdrop — do you agree with the consensus views? How will this impact emerging market debt?

I agree with the consensus view on global growth. While acknowledging how painful and difficult the pandemic has been, it has been different to other crises, where we have seen a large destruction of human and physical capital or we have had the financial system unable to provide financial intermediation. Given that we have some visibility on the end of the pandemic, we can expect the global economy to rebound strongly. I think that the consensus around the US leading the way is correct as well. The US exports a lot of its growth because of its size and because of its large current account deficit.

This positive outlook, led by the US, is a particularly good one for emerging market debt, given the importance of growth for the asset class. Growth generates income in EM countries, supports the fiscal situation and helps address external vulnerabilities. Overall, global growth should reduce the risk premium in the asset class.

What investment opportunities do you see in EM debt today?

Overall, I think credit improvements in the cyclically exposed economies is a real opportunity, which we can express through higher yielding US dollar debt. Within local currency, we see value in many EM currencies and attractive carry. Duration is more attractive in local currencies than hard, particularly in the current account surplus countries.

Looking at these more closely, there is a bifurcation within the US dollar market. The investment grade portion of the dollar market (around 60%) is generally longer duration, sensitive to movements in US Treasuries, with very defensive tight spreads. That part of the universe looks expensive to me and I see very few opportunities there. Meanwhile, the ratio of spreads between the investment grade part of the universe and the high yield part is one of the highest we've seen in a very long time. So the higher yielding part of the universe looks quite attractive, with the added bonus that it is shorter duration and so less sensitive to movements in US Treasuries. It is also the most cyclically exposed part of the universe and so better positioned for the reflationary environment.

Within local currency debt, I see opportunities for duration mainly in the Asian current account surplus countries such as China and Malaysia. In countries where we like the currency and the carry but worry about inflation, such as Brazil and Turkey, we can use inflation linked bonds or stay very short duration.

Corporate bonds in general are looking less attractive now after the stellar results seen recently, but they still offer good diversification and the ability to take shorter duration with some yield pick-up relative to the relevant sovereign.

How are you positioning for the recovery from COVID-19?

I'll make three points. Firstly, the countries that are exposed to trade, especially tradable goods, should do particularly well as we continue to see a sharp rebound in trade. Secondly, I am more cautious with regard to countries heavily dependent on tourism. My baseline view is that people still want to travel, but the recovery in tourism may be slow and there may be more government intervention. Thirdly, I see the most uncertainty around the political consequences from COVID. While EM countries should have an easier time reducing monetary and fiscal stimulus as they generally didn’t go overboard in the first place, I worry that some governments may be judged very harshly for how they dealt with the pandemic, increasing the risk of political instability.

Risk factors you should consider before investing:

• This material is not intended to provide investment advice or be considered a personal recommendation.
• The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
• Past results are not a guide to future results.
• If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease.
• Depending on the strategy, risks may be associated with investing in fixed income, derivatives, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.