Emerging markets have faced numerous headwinds so far in 2018. The current trade dispute between the US and China has been unhelpful, while rising US interest rates and a strong dollar pose problems. Elsewhere, we’ve seen troubles in countries like Venezuela, Argentina and Turkey.
The two worst-performing sectors in the Investment Association universe are emerging market focused: while global emerging market equity funds have struggled, with the average fund losing 4.2% year-to-date, global emerging market Bond funsd have been hit harder.
So far in 2018, the average fund in the sector is down 5.21%. Over the past 12 months, that figure stands at almost 7% and it is the only sector to have lost investors over 2% in that period.
But some fund managers are paid to be contrarians, and many unconstrained bond fund managers are seeing value in some parts of the emerging market debt space. Of course, they can go anywhere globally, so can pick and choose their exposures.
Jon Jonsson, manager of the Neuberger Berman Global Bond Absolute Return fund, says he’s recently completely moved out of US high yield and into both European high yield and emerging market hard currency.
He notes that, with emerging market spreads widening out dramatically in recent months, we haven’t seen the kinds of mispricing between emerging market debt and US high yield since the late 1990s.
“And EM is much better quality now than 20 years ago, so those spread differences look even more attractive,” he adds.
US May Struggle With Growth Expectations
These dislocations have been caused by a number of factors, including the breakdown in the synchronised growth of 2017. Now the US is powering ahead and other parts of the world are disappointing, expectations for US growth are very high.
“I expect that it will be difficult for the US to meet those expectations and US high yield is very sensitive to growth expectations,” adds Jonsson.
Rising interest rates are a potential negative for emerging markets and Ken Leech, chief investment officer at Western Asset, says that is traditionally the case. However, he counters: “Central banks lowered rates between 2013-2016 by around 50 basis points; what did emerging market bonds do? They got killed.”
His suggested reason for this anomaly is that fears of weak global growth overwhelmed the supposed positive effect of higher rates.
“Could the opposite be true? Could the global growth benefits overwhelm the mild tightening you see from central banks,” Leech, who runs the Morningstar Bronze Rated Legg Mason Western Asset Macro Bond Opportunities fund, asks.
“Ultimately, global growth is the key to whether emerging markets will do well. If global growth is sturdy, then emerging markets should do well.”
Of course, there are risks to banking on above-trend global growth continuing. China is already slowing, and fears around a hard landing have been elevated for years. But Jonsson thinks the slowdown will continue gradually, as it has so far. “Ultimately it could be a big car crash, but we think they still have policy options to manage this slowdown.”
An all-out trade war is also a worry. But movement on the NAFTA front this week shows there’s scope for those fears to recede.
Ultimately, Jonsson says, it’s a relative value call. “There’s so many potential problems… but I think I’m being compensated for those potential risks. It’s all about valuation versus the risk you face.”
