EM Monitor – the opportunity from dispersion in emerging market debt
March 2021
Marketing Material
EM: this time it's different(iation)
Digging under the surface of emerging market fixed income reveals multi-layered dispersion, both across countries and capital structure.
Written by
Ketan Gada
Head of Total Return EM Fixed Income
Gareth Payne
Head of Credit & Alternative Fixed Income Client Portfolio Management
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Real yield advantage
In an income-starved world emerging market local currency debt offers an attractive inflation-adjusted yield (real yield) pick-up over developed markets, as the charts show below. This is despite EM real yields being some way off their absolute highs.
Pick me up...
Fig.1: EM vs DM real yield evolution and differential (bottom chart)
Source: Bloomberg, JP Morgan. March 2021. The EM real yield is calculated by taking equal weighted country yield of countries in JP Morgan GBI-EM Global diversified index minus the latest CPI print for: Poland, Hungary, Romania, Russia, Turkey, South Africa, Mexico, Brazil, Colombia, Chile, Peru, Indonesia, Philippines, Malaysia, Thailand and using the Bloomberg 5Y generic bond yield - latest CPI for China
The long and short of it...
The asset class has more dimensions to offer however. As a long-short manager we are continually looking to exploit the dispersion within emerging market fixed income – see Figure 2 for the wide divergence of real yields across countries.
EM is not a homogeneous asset class and taking a purely top-down view risks overlooking many critical differences below the surface. What is required is individual country and asset selection. We believe a strategy that uses long and short positions is particularly well suited to generate excess returns from such dispersion.
Real yield dispersion
Fig. 2: EM and DM real yields
Source: Bloomberg, JP Morgan. March 2021.
Differentiation goes deeper
Dispersion in real yields is just one part of the puzzle when looking to unearth alpha in emerging markets. Also important are GDP growth dynamics, fiscal and monetary impulses, and technical factors such as momentum, flows and local policy.
The intersection of global and local factors in EM fixed income investing
Fig. 3: Our framework for blending top-down and bottom-up factors
Source: Pictet Asset Management
Figure 3 is our framework for analysing the EM opportunity-set. First comes an assessment of global financial conditions and the macroeconomic backdrop. Next we unpeel the layers of how these impact each emerging market from the bottom-up. Impacts are not uniform given the idiosyncrasies of each country. An added dimension is asset reaction function, as macroeconomic factors may have differentiated effects on the different parts of the EM capital structure. For example on rate curves, sovereign credit or the currency of a country.
The aim is to decide for any given market and specific debt instrument if the potential return adequately compensates us for the risk profile of local rates, FX volatility, inflation and domestic institutional risks. The challenge is using the correct lens depending on the country in question and, critically, assessing time horizons.
Dispersion in a post-Covid world
We think the value of our long-short approach has never been more relevant than today. Especially as we look at the massive fiscal response to Covid-19 and assess each country’s ability or willingness, to tighten the purse strings and the pace at which that may happen.
Some of the highest yielding countries, such as Brazil, South Africa and Turkey are at a crossroads. Their loose policies in 2020 will make the year ahead very challenging as they look to re-open and rebalance their economies. The fiscal deterioration has impacted their external credit worthiness, causing local rates markets to begin to price in a higher credit risk premium.
Some of the highest yielding countries are at a crossroads, but we don't expect a systemic crisis for emerging markets.
But we don't expect a systemic crisis for emerging markets. The backdrop of accommodative global central bank policy and huge fiscal provision, plus a better starting point for many of the EM countries, should ensure that.
How each emerging country emerges from today’s unprecedented environment will vary. Widely disparate economic and fiscal metrics, fundamentals, socio-economic backdrops and political willingness to adapt, will all play a part. We believe EM is a multi-layered landscape that lends itself to a long-short approach, and, for nimble investors with strong analytical skills, offers excellent opportunities to generate uncorrelated alpha.
About
Ketan Gada
Ketan Gada joined Pictet Asset Management in 2016 as a Senior Investment Manager in the Total Return Emerging Markets team.
Before joining Pictet, Ketan was a Partner and Senior Portfolio Manager at Quadra Capital Partners, where he managed a Emerging Markets Long/Short fund. Prior to Quadra, he spent ten years at Blackrock and Barclays Global Investors as a Managing Director running Emerging Markets strategies within the hedge fund Fixed Income Global Alpha.
Ketan began his career in 1998 at Cargill managing proprietary Emerging Markets risk.
Ketan holds a Master of Business in Finance and Strategic Management from the University of Minnesota and a BA in Finance from the University of St. Thomas.
About
Gareth Payne
Gareth Payne joined Pictet Asset Management in February 2019 and is Head of Credit & Alternative Fixed Income Client Portfolio Managers.
Before joining Pictet, Gareth was the Client Portfolio Manager for Man GLG’s Credit and Convertibles business with responsibility across both alternative and long-only strategies. Prior to that Gareth worked in a number of business development roles at Man’s multi-manager hedge fund unit, FRM. He began his career in 2007 at Lehman Brothers in London.
Gareth holds a Masters and BA from the University of Cambridge
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