Fixed Income and Emerging Market Currencies
EisnerAmper’s Trends Watch is a weekly entry in our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you would like to be featured, please contact Elana Margulies-Snyderman.
This week, Elana speaks with Scott Grimberg, Head of Emerging Markets Debt, Itau USA Asset Management.
What are your prospects for investing in fixed income and emerging market currencies?
While my longer term outlook for fixed income and emerging market (EM) currencies is generally positive for a variety of demographic, growth and leverage reasons, the near to medium term environment is quite challenging. The external (non-emerging) environment faces two major issues: slowing growth in China and rising US (and developed) markets. [DM]) interest rate. This means that yields (real and implied) must rise, not only to keep pace with returns in “funding” currencies (especially USD), but that the “premium” (eg spreads) must also increase to compensate for volatility and risk. Emerging assets are therefore under pressure, as is the rest of the universe of “risky” assets. Over the medium term, we expect stimulus in China, particularly fiscal stimulus and infrastructure development, as well as greater clarity on U.S. interest rates, to stabilize emerging market asset markets and significantly improved yields. Longer term, we expect that demographics, lower leverage and higher growth in emerging markets relative to emerging markets will necessitate flows of assets from the developed world to the emerging world in order to capture premiums and higher yields that are not available in developed world asset markets. Over the past 25 years, emerging markets (including China) have tripled their share of global GDP and trade while representing the same percentage of global capital markets (about 11%) as 25 years ago. We note in particular that emerging markets are, for the most part, much less leveraged (e.g. (equity + debt)/GDP) than the developed world (with a few notable exceptions, such as China and Brazil), which will allow, under the right conditions, sustaining higher long-term growth rates. Furthermore, this relative under-leverage also means that emerging markets will be able to expand their public and private asset markets at a faster rate than developed markets for many years to come.
What are the biggest opportunities you see and why?
Commodity-exporting countries (especially those in the Middle East and Latin America), countries with current account surpluses, and companies with strong cash flows as financing costs rise. As we move out of the era of ultra-low interest rates, countries and companies less dependent on external financing and with low debt carrying costs will not only be able to weather the funding crunch, but also benefit from better liquidity positions to support national growth (countries) or gain market share (companies). So, in addition to riding the wave of commodity exporters and issuers who can take advantage of the commodity price shock, investors need to identify places (countries, companies, etc.) that can benefit from the reshuffle. global supply chain. The past couple of years have taught us (and the corporate world) that relying on a narrow or single source in supply chains leaves us (them) vulnerable to sudden shocks and shutdowns. Additionally, as foreign investors face additional barriers to investing in China, there will be a demand for different, or at least alternative, sources along supply chains. Emerging market professionals are well versed in identifying the policies and balance sheets that allow countries to attract both foreign direct investors and portfolio investments. This will be a source of outperformance and long-term returns for emerging market investors.
What are the biggest challenges you face and why?
We are emerging from a multi-year cycle of mega-liquidity that has allowed ALL risk assets to perform well. The difference between “good” and “bad” policies of countries and companies has been minimized by the abundance of liquidity. Investors will now have to adjust to a world of scarce liquidity, which means higher premiums and a wider yield gap between “good” and “bad”. This will force investment professionals, especially in emerging markets, to look beyond a ‘bounce’ after a sell-off (or rally). More importantly, investment professionals will need to guide portfolios (and clients) towards the potential for longer-term returns.
What keeps you up at night?
What keeps me up at night is that in the 30 years I’ve been investing, I haven’t seen a Federal Reserve tightening cycle that hasn’t led to some kind of liquidity or , worse, to a credit crisis. By nature, these crises come from sectors that are not only underinvested, but also tend to mask their volatility and risks (bubbles are usually identified after the fact). I suspect that the past few years of monetary stimulus have led to a bubble in global government bonds, especially in developed markets. In retrospect, negative real returns weren’t exactly sustainable, and worse, negative nominal returns seem even more extreme. Right now, investors have deflated the nominal yield bubble, forcing them back into positive territory, but real yields (observed but not implied by inflation-protected Treasuries) remain in negative territory. The impact of negative yields (real and nominal) has been an explosion in debt issuance (public and private), particularly in developed markets (although emerging market issuers have certainly been active as well). I don’t know if this is a bubble that will lead to a crisis, but I suspect the ultra-low yields have hidden serious credit issues. Worse still, governments can ill afford politically for inflation to wipe out the real value of the debt, so they will have to find a way to reduce the debt, pay it down, or service their debt.
I am also very concerned about the frontier markets, which oscillate between unsustainable indebtedness and sharply rising food and fuel prices. I wonder how the border countries, which depend on food and energy imports, can maintain political and economic stability over the next 18 to 24 months, unless something significant happens, such as a drop in food prices or a large-scale multi-commodity infusion. lateral financial support. I fear that many low-income countries will experience a gradual breakdown in politics and governance, while more authoritarian ones may eventually collapse (as we saw in the Arab Spring).
The views and opinions expressed above are those of the interviewee only and do not/are not intended to reflect the views of EisnerAmper.
The opinions expressed below are those of Scott Grimberg, Head of Emerging Markets Debt at Itaú USA Asset Management, Inc., and do not necessarily reflect or represent the opinions or position held by Itau USA Asset Management, Inc. .or its parent company.