This week the FundCalibre team explore the opportunities and challenges within emerging market debt with Polina Kurdyavko, co-manager of the BlueBay Emerging Markets Unconstrained Bond fund. They discuss the current landscape of fixed income, the dislocation in sovereign debt spreads, and the role of local currencies and geopolitical shifts in shaping future returns.
Why you should listen to the interview: Polina provides a comprehensive breakdown of why emerging market debt offers a compelling opportunity in today’s investment landscape. From unique growth stories in countries like Brazil to potential gains in frontier markets post-restructuring, you’ll learn how to navigate risks and capture upside in these diverse economies.
This interview was recorded on 11 September 2024. Please note, answers are edited and condensed for clarity. To gain a fuller understanding and clearer context, please listen to the full interview.
Interview highlights:
“The stars are aligned”
“If I think about the EM fixed income landscape, we have a very interesting combination of the valuations against the fundamentals.
“On the valuation side, emerging market fixed income investors today in hard currency are getting yield on the index level close to high single digits, which is amongst the highest yield over the last two decades. And yet, if we think about hard currency default forecast, starting with sovereign debt, we would expect sovereign default rates to be zero this year and next, after almost four years of high single digit defaults. This in itself is a very attractive combination.
“On the corporate side, we expect defaults to remain below historical average of 3.5% going forward. So the corporate fundamentals look quite healthy, yet when it comes to valuations and the dislocation in spread, the biggest dislocation we’ve seen is in hard currency sovereign debt, hence that’s where we see the best opportunity.
“I would also say that when we look at emerging markets, local currency debt, the asset class that has been out of favour for a good part of the last decade, given the devaluation of local currency. It feels to us that over the last couple of years the tide has been turning and there is a potential for outperformance of select local currency names as well, which after the US election could prove an interesting opportunity for investors.
“The last point that I would mention is technicals. Despite the fact that the asset class has registered double digit returns last year and is in high single digit returns already year to date on the index level, we haven’t seen as an industry slows in the asset class over the last two and a half years. They’ve been outflows from the asset class. We feel that’s likely to change. And actually, if anything, it gives investors a very clean technical backdrop combined with high valuations in a benign outlook for defaults. Overall, I would say, all the stars are aligned.”
Geopolitical risk isn’t always negative
“In fact, if anything countries like Mexico have benefited from the near shoring trend. Countries like India have benefited from low oil imports prices given the discounts they’re getting when they purchase their oil after the Russia/Ukraine war. So a number of countries have been indirect beneficiaries of higher geopolitical tensions in the world. So to me, that outlook speaks quite constructive for the local currency performance.
“On the other hand, if we look at the dollar, it’s important to note that right now it’s a period of high uncertainty given we are yet not through the US elections, but once elections are out of the way, there is a narrative for potentially weaker dollar given the focus on some of the candidates on increasing growth, but also reducing inflation and increasing exports for which weaker dollar is more favourable. So the combination of those two factors could mean that going forward next year, we could see the continuous trend of strengthening local currency against weakening US dollars, which we’ve started to observe couple of years ago.”
The China recovery story
“While the narrative for China slowdown has been quite widely spread, if you look at the Chinese exports data, it actually has been going stronger – both in volume terms and in price terms. So if anything, when we talk about Chinese slowdown, it’s more a slowdown related to weaker domestic demand, not necessarily a slowdown of exports for that matter. And as a result we’ve seen other emerging market countries benefiting from this, partially given the overall volume of exports, but also partially given the redirecting of those exports into some of the Asian economies on the back of the tariff hikes that has come through from the US and Europe.
“And therefore perhaps going back to my earlier comments, if you look at the broader growth narrative in emerging markets, if anything, it has surprised markets over the last couple of years on the upside, not the downside. So in our view, Chinese slowdown per se is not an impediment for growth in the rest of emerging markets as well as developed market economies.”
Conclusion: Emerging market debt presents a promising opportunity for investors seeking strong returns in the current environment. With high yields, improving fundamentals, and supportive technicals, this asset class offers diversification and growth potential. As the global economy evolves, understanding these opportunities is key for making informed investment decisions in both hard and local currency markets.
