Seventy-eight billion dollars has flowed into emerging market debt in the last nine months, as capital scours the globe for yield, and a strong economic recovery could pay out big for investors who have taken on the risk.
Arif Joshi, portfolio manager and analyst – emerging market debt, at Lazard Asset Management, expects $100 billion to $120 billion dollars of emerging market debt inflows to arrive during 2021, making it the second largest year ever for the asset class.
“There are countries that are going to use that opportunity wisely, where they refinance their debt and invest in capital projects to get the growth they are capable of,” Joshi says.
“And there will be countries that do the opposite, operating on a macro prudential framework that is negative for their countries,” he says. Though Joshi warns the bond and currency markets will sniff out mismanagement and investors will experience losses in those areas.
“It’s not the Buffett time where, when the tide rolls out and you see who’s naked, the tide here is very, very high.”
Michael Biggs, macro strategist and investment manager at GAM expects global growth to continuously revise higher over the next couple of quarters and will bode well for emerging markets.
Pointing to the unique scenario where policymakers will only remove stimulus if inflation occurs, Biggs says the length of the stimulus will boost growth higher particularly since US GDP is placed around where it was before the pandemic struck.
“Private sector savings rates are coming down and boosting demand,” Biggs says. “Usually you’d have government raising its savings rate as a headwind, but we don’t have that, so we think we’ll see a substantial upside.”
Europe, though it has had a difficult first quarter, will follow a similar growth trajectory once vaccinations are rolling out smoothly, he says.
This big rebound will bode well for emerging markets, Biggs adds, as Chinese demand for emerging market exports isn’t fully priced into markets yet.
Joshi agrees the current market is underestimating the global growth rebound, and adds emerging market growth will likely get started towards the end of this year and into 2022.
“The growth we know about now is front loaded,” Joshi says. “US Treasuries and the US dollar are the biggest pressures on emerging market debt, but we think that will start to shift as you get further along in the year.”
A rosy outlook for commodities is another positive catalyst for emerging markets, though Biggs points out the tricky fiscal situation of two of the main commodity producers means GAM is reluctant to be overweight.
Joshi says the locked growth potential of emerging markets combined with the “one of the greatest V-shaped commodity growth recoveries the global has ever seen” offers investors a powerful opportunity.
“If it’s appropriate for that country to realise its potential, then it can grow double and triple the general run rate in the developed world,” Joshi says.
“You will make outsized gains if you can determine which forward looking policies in these countries allow for that.”
The sharp uptick in investor interest in Environmental, Social and Governance (ESG) criteria also benefits investors who can determine improving governance issues like central bank credibility and constitutional amendments to limit fiscal deficits, says Joshi.
“Emerging market investing has always had a governance issue, you’re always wondering if you’re going to get paid your money back,” Biggs says. “That’s a crucial part of the strategy.”
Turkey’s recent firing of the central banker in the middle of the night, and resulting market collapse, highlights just how unpredictable and risky investments without solid governance protocols can be.
“You need to know whether the policy framework is a sustainable one,” Biggs says.
Engaging with sovereign powers is much more complicated that dealing at a company level, say both panelists, agreeing a collaborative approach is critical.
Joshi, who was in Sudan at the time of the conference, describes the recent confirmation that the northeast African country would have its debt slate wiped clean.
“In the emerging market world, there are countries that have been very successful at taking a blank slate and putting in proper governance and economic management,” Joshi says.
Cote d’Ivoire is an example: it was in a civil war twelve years ago, but now runs a 45 per cent debt-to-GDP ratio and they grow at 8 per cent.
“That’s what’s great about emerging market debt, when you take that risk to get that extra yield, it’s not just balance sheet risk,” Joshi says.
“It’s that they only have twenty years of modern economic history, so they have to run better balances unlike the developed world where you can print your own currency and other people actually want it.”