As Emerging Market Debt (EMD) continues to grow in absolute terms and as a percentage of institutional investors’ portfolios, CAMRADATA’s latest whitepaper on Emerging Market Debt highlights that questions for investors and their advisors in 2022 revolve around risk and correlation.
The whitepaper includes insights from firms including Emirates NBD Asset Management, Payden & Rygel, Charles Taylor Investment Management, Redington, Russell Investments, SEI Investments and WTW, who attended a virtual roundtable hosted by CAMRADATA in January.
The report highlights that EMD spreads offer an initial attraction versus other kinds of public fixed income, as bad management at issuing corporate and sovereign-level can be mitigated by good active selection among the widening pool of choice.
Healthy current accounts, more than in many Developed Market (DM) treasuries, are a buffer for most Emerging Market (EM) sovereigns. Growth prospects in Asia especially remain superior to richer, mature regions such as Western Europe. Yet risks remain for investors.
Natasha Silva, Managing Director, Client Relations, CAMRADATA said, “Last year demonstrated that in times of uncertainty, foreign capital withdraws from emerging markets. Future risks include the impact of possible rate hikes in the US as it recovers from the pandemic faster than most other nations and the strong US dollar’s contribution to poor returns from emerging market local currency issuance.
“Investors also need to consider the green energy transition and what it means in emerging markets. As many rich-world institutional investors set pathways for decarbonising their portfolios, this presents threats and opportunities for emerging market borrowers. Our panel considers these factors and how lenders will be increasingly evaluating these as ESG deepens and spreads.”
The event opened with investors in Emerging Markets acknowledging they have had a tough time recently as waves of the pandemic forced governments to spend extraordinary amounts to protect their populations. Returns have been poor on an absolute basis, and really poor relative to some sectors of Developing Markets.
When they were asked how sectors of EMD would fare over the next 18-24 months, the responses were varied. They also debated whether EMD managers ought to be selected on a benchmark-aware or Total Return basis, and also considered what risks lie ahead in EMD.
The final topic of the event was ESG and the challenges of mapping portfolios to a Net-Zero Carbon metric.
Key takeaway points were:
- In terms of the risks currently in EM, one panellist noted that the average duration for hard-currency high quality sovereigns was eight years, which makes this asset class very sensitive to the changes in the interest rate, particularly in the 10-year area. That matters in a world expecting more rate rises.
- Most panellists expect three rate hikes by the Federal Reserve in the US, resulting in a 1% rate by the end of December.
- Looking at the risks in EMD a panellist noted that at the start of 2021, the consensus had been that markets were set for stellar performance. That did not materialise in 2021, so how could it be different this year?
- Two reasons were offered: First, valuations look even more attractive than 12 months ago. Second, as money flows out of other asset classes (on monetary and quantitative tightening) which seem overvalued and could potentially be volatile in the short term, flows may return into ‘spready’ products.
- There was geopolitical risk, notably Russia and China’s ever changing regulatory environment.
- Other risks are that markets will be more sensitive going forward as central banks remove support. That could mean more volatile flows and reaction to news and noise.
- On the direction for commodity prices, one panellist said the outlook for 2022 was pretty positive. They saw strong demand from the US and Europe albeit with risks in the form of OPEC intervention in oil production or China reducing industrial production if another Covid lockdown was required.
- Turning to ESG a panellist said that countries still developing economically like India could not be expected to switch to renewables overnight, adding they live with frequent power outages already.
- Another warned that complexity and nuance between separate E, S and G issues was no reason to simply exclude certain issuers. While many countries scored lowly on ESG; that was probably a reason to engage with them
- One firm said clients expect that their investment managers have ESG policies and are compliant with the latest regulatory demands and this led to them coming up with a sustainability framework for all its asset classes, including EMD. The target for EMD is to achieve one-third fewer CO2 emissions than the benchmark.
- It is a struggle to ‘walk the line’ as a Net-Zero aligned investor, with one panellist saying you could be green in some parts of your portfolio but not all, and not necessarily aggressively in EM where E and S can conflict. It is difficult with clients because unless you refine the reporting, EM just scores a big red number.
- Engagement is vital and it is important to keep the conversation going. Even if a finance minister does not want to hear what a bondholder believes, if he hears the same message from sixty bondholders, then there will be an effect.
- These kinds of conversations were already having a positive effect. A final comment was countries are putting together much better information on ESG in virtual roadshows, for example on carbon exposures and how they intend to diversify the economy. Engagement by investors is bearing fruit in terms of countries being more aware and divulging more information.
Additional insight is offered in the whitepaper with x articles from the sponsors:
- Payden & Rygel: ‘Don’t Stop Believing: EM Inflation Journey and Central Banks’ Response’
- Emirates NBD Asset Management: ‘Inflation: Drivers, Effects and Response in EM vs DM’
To download the ‘Emerging Market Debt’ whitepaper, click here.
For more information on CAMRADATA visit www.camradata.com
