It may seem strange to consider Emerging Markets as a potential safe haven, but arguably, that is now the view of many of those looking to mitigate the political uncertainties in Europe and the US.
In the past six months, there have been strong inflows into Emerging Markets equities and bonds.
The political argument is one driver — we can now add a UK general election to the French presidential election and September’s German election, which are creating uncertainty in Europe.
In the US, we see Trump struggling to push through the reflationary economic agenda that has driven equity prices recently and taking an interventionist foreign policy approach that runs completely counter to his election promises.
Emerging Market countries, in contrast, are enjoying improved political stability and with commodity prices resurgent, we are optimistic about the fundamentals.
Focusing on credit specifically, demand for Emerging Markets credit is growing and supply and demand dynamics are skewed in favour of bond prices rising. We have seen a couple of months of abnormally high maturities. March saw Emerging Market fund managers receive $12.1bn in maturities. In April it was $34bn. This is money that managers are having to reinvest at the same time as dealing with fresh inflows.
The second driver of demand is returns. Though valuations everywhere look tighter than they did a year ago, there is still an attractive premium for holding Emerging Market credit. At the end of March, the BBB spread was 1.9% against just 1.3% in Europe — a difference of 33%. Emerging Market high yield spreads were 4.25% versus 3.75% and 3.45% for the US and Europe respectively.
Tension between North Korea and the US may feel to some like a cause for anxiety, but we believe that while the US and China are working in tandem on this problem the risks are reasonably low. The clear concern is South Korea, but this is a country with more dollar reserves than it has dollar debt.
One of the great appeals of Emerging Market debt is the diversity of attractive investment options now available to managers — sectorally and geographically. Selective bottom-up managers can deliver diversified portfolios that truly do mitigate some of the risks in developed markets.
A version of this article first appeared in Investment Week on 1st May 2017.
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