Fewer bargains left in fashionable emerging markets

Fraser Lundie, co-head of credit at Hermes, and Andrey Kuznetsov, senior credit analyst, discuss the outperformance of emerging markets this year but warn that a selective approach is required from here on.

Fewer bargains left in fashionable emerging markets

Global high yield managers have this year been able to enjoy a significant tailwind from their allocation to regions outside of the US and Europe. Emerging market corporate bonds have undergone a remarkably rapid transformation from one of the least-loved asset classes to perhaps the most popular.

This move has been driven by several factors. First of all, a major tailwind has been the relative attractiveness of emerging market debt compared to developed market fixed income, where close to half of the market yields below 1%. Secondly, the year-to-date stabilisation in many commodity markets has provided relief for many emerging market economies that rely on these exports for a substantial part of their GDP. And thirdly, the expectations of a lower-for-longer interest rate environment and a weaker dollar has helped emerging market currencies recover.

As a result inflows into emerging market hard currency funds continued, pushing year-to-date cumulative flows to $12bn, or 9% of their current AUM. Issuance has picked up recently but remains at its lowest level in the last four years, aiding the supply-demand technical which remains very supportive.

Along the way, we have been exercising our global remit to find opportunities which stand out in comparison to developed market peers. We have invested in global players with strong fundamentals and underappreciated recovery stories such as steel players Severstal and Gerdau, in Russia and Brazil respectively.

Increase vigilance and move up in quality valuations have now largely normalised despite the risks still remaining – primarily a renewed declining of the oil price and other majority commodities prices. Indeed, a Fed rate hike and geopolitical risks also remain as potential deterrents to continued outperformance.

It is essential to combine a thorough assessment of operating, financial and ESG risks to identify companies that are able to prosper in an environment where many emerging market economies are still struggling to return to growth.

A return to fair value compels us to remain up in quality and highly selective as the low-hanging fruit of the trend is now behind us. That said, given the siren call for yield persists, and the exogenous catalysts of the BoE and ECB programmes are expected to endure, it is more important than ever to fully exploit flexible, global mandates to eke out returns where risk is deemed appropriate.

 

Please remember, no news or research item is a recommendation or advice to buy. Every Investor is not responsible for accuracy and may not share the author’s views. If you are unsure of the suitability of any investment for your circumstances please contact an adviser. All investments can fall as well as rise in value so you could get back less than you invest.

 

** Find out how your favourite stocks are performing now using Company REFS – the ultimate stock pickers tool. Try now with a 30 day free trial **

Enter your e-mail address to receive updates straight to your inbox

My Newsletter

You can easily unsubscribe at any time by clicking on the unsubscribe links at the bottom of each of our emails

About Author