Thursday, May 19 2022

Whether in Latin America, Nigeria or Oman, emerging markets offer a wide range of credit allocation opportunities, says Aaron Grehan, deputy director of emerging markets debt and the hard currency portfolio manager of ‘Aviva Investors.

Many see emerging market debt as a volatile asset class and a tactical investment, but the asset class can make strategic sense, said Grehan Investment magazine Podcast on Market Stories.

“Emerging market debt is considered a very volatile asset class and it does not need to be associated with a mix of investment quality and high yield. It doesn’t have to be a volatile asset class, it can be managed more defensively, ”he says.

In an effort to generate the higher returns that people expect from emerging market debt, many fund managers tend to favor higher-yielding or lower-rated assets, which negates certain patterns that can perform well on. strong markets but underperforming bear markets, says Grehan.

“There is a lack of consistency on the part of many managers in the universe and a higher beta or directional element of risk which we believe can lead to a misperception of the asset class and the results that are attached to it on the part of the underlying investors. “

Aviva Investors’ approach seeks a more consistent balance between investment grade assets and high yielding assets to eliminate these biases and use the full spectrum of the asset class, such as high quality, to push back ideas. false and create a more structural allocation.

“We believe that the asset class, although it has its challenges, still deserves structural allocation and should not be used as a tactic like many investors still do,” said Grehan.

He says the macroeconomic risks of rising inflation and uncertainty about the growth outlook are overstated and the outlook appears to be more favorable than the commentary suggests.

“Ultimately, we believe that favorable conditions will persist for financial markets and that they will continue to provide good conditions for the performance of emerging market debt assets,” he said.

An impending US Federal Reserve announcement to cut bond purchases should not be taken as a hawkish signal, Grehan said.

A much higher interest rate, in the United States or around the world, is a risk, but the current movement is transient and the US central bank is unlikely to be forced to react and move forward with interest rate hikes.

“We believe they will continue to be progressive and patient and focused on growth and supporting the recovery we are in,” he said.

“Regarding the growth outlook, expectations have cooled from the greater optimism that existed in the first quarter of this year, but the outlook is still positive, a weaker and slower recovery than initially expected but still favorable to financial assets. “

Diversification is the key

Emerging market debt as a hard currency, both sovereign and corporate, can help investors manage changing macroeconomic conditions by moving from investment grade to high value for credit beta, a- he declared.

“In today’s environment, a move towards higher quality, higher yield can protect you against rising rates and give you something more resistant to just a quality allocation,” said Grehan.

“Then the ability to use the investment grade and change your allocation gives you more protection against growth issues or a real downturn in outlook compared to just a high yield allocation. “

The risk for emerging markets is that pressures on inflation and interest rates in the United States will begin to intensify and become more structural, causing borrowing costs to increase for all countries that issue in dollars. Americans.

A “double whammy” could also occur if growth slows more than expected in China and if the outperformance in the United States puts upward pressure on interest rates leading to liquidity and insolvency problems for some. emerging market borrowers.

“The worst-case or worst-case scenario is an increasing default rate in our universe, as borrowing costs become unsustainable or markets are not open and countries are unable to finance debt. “

China’s growth prospects have a greater impact on the Asian region and commodities, but Latin America, although differentiated by some dependence on commodities and China, would benefit from the American economic growth.

“Generally speaking, a weaker Chinese outlook would have a negative region and commodity exports, while countries with closer ties to the United States would perform better.”

Grehan says that tremendous growth in emerging market companies over the past 10 years has shifted some of the allocation of emerging market debt to a stand-alone status in the context of global credit.

“Investors need to catch up on the asset class, maybe it’s been viewed from a historical perspective, rather viewed in the scale, the benefits, the diversification that it didn’t offer there. 8 to 10 years old, ”he says.

Emerging opportunities

Looking for opportunities, countries that are less vulnerable and exposed to short-term debt, with a diversity of funding sources, good local market access and policy improvements are in Aviva Investors’ sights.

“The countries that stand out for us right now and offer good risk to reward are Nigeria and Oman, names that could be seen as slightly ‘racy’,” said Grehan.

“In the case of Nigeria, your debt to GDP is relatively low, you have low short-term debt, so there is no risk of liquidity problems, and the benefit of rising oil prices. for this year and next year, ”he says.

“This ratio with a yield of around 7-8% along the curve offers an excellent prospect of generating sustainable returns with low volatility. “

Meanwhile, Oman is more than an oil credit allowance, he says.

“But we’ve seen a real improvement in the policy over the past two years. There is strong pressure for reforms, but there is a strong improvement in the fiscal outlook that is not fueled by oil, ”said Grehan.

“The factors are positive, it is a re-rating story that will continue to improve and reverse the credit downgrade that has taken place over the past few years.”


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