Given the recent exodus of money from emerging markets and much increased EM currency volatility, certain governments are turning to hard-currency bond issues – and investors would be well advised to buy them, argued BlackRock's head of EM fixed income yesterday.
Prior to the EM rout, sparked largely by the US Federal Reserve’s hinting in late May that it would start tapering its stimulus programme, EM governments were well set in terms of financing, said Sergio Trigo-Paz. He was speaking on a panel at a forum in Hong Kong organised by the US fund house.
Beta players seeking double-digit returns have been exiting the market, while alpha players – who view the asset class as a medium- to long-term strategy, particularly in hard-currency debt – are coming in, says London-based Trigo-Paz.
Moreover, “when [Asian] countries were enjoying Chinese tailwinds and quantitative easing, investors were basically all moving into local markets,” he notes. “So countries had plenty of money to finance locally on their own terms. But now that their currencies have gone very volatile, these investors are not there any more.”
As much as 60% of the money financing local EM markets had previously been from overseas, so some countries are now struggling to roll over debt, he notes. Hence some governments are trying to go back to the dollar bond market, says Trigo-Paz, citing Monday's issue by Russia's government of $7 billion in bonds comprising dollar and euro issues.
“What you’re going to get is that all these countries are going to pre-fund as fast as they can whenever there is a calm in the storm.” He argues that this “heavy supply” of issuance is likely to be disruptive, but “once we get through it, we will have very good investment opportunity”.
Trigo-Paz argues that buying dollar-denominated EM bonds is broadly advisable right now, given the difficulty of predicting the movement of emerging currencies and that the dollar is expected to strengthen.
“Some investors are asking where should I buy, which currency is cheap,” he says. “My advice is don’t try to catch the falling note. It’s not a retracement story – it’s just about looking at the dynamics of the country."
Trigo-Paz argues that investors targeting local emerging currencies should be looking for 7.5-8% returns – rather than the current yield of around 7% – to cover the FX volatility.
Moreover, the dollar is likely to strengthen, he adds, and hard-currency debt is paying about 6% in dollar terms. “That’s very attractive, because in US Treasuries you’re getting something close to 4%.”
Meanwhile, EM stocks have performed like their countries’ currencies in the past three months in particular, says Andrew Swan, head of Asian equities at BlackRock, speaking on the same panel. And he feels they may well fall further.
The outperforming currencies have been those in North Asia, because they have current-account surpluses and low foreign ownership and therefore low funding needs, he notes.
Underperforming ones have included Southeast Asian countries and India, because they are externally financed to a large degree and have relatively high foreign ownership, says Swan.
In some cases the outflows have been an overreaction, while in others there’s still some way for them to go, he adds. If Asian stocks were to fall another 10-15%, “we will be at bottom-decile valuations – and you will make money [if you get in] at that point. It feels like the wrong thing to do, but you will make money.
“And we may get [to such valuations], because of some of the challenges we face before we get to sustainable, quality growth," says Swan.
More sustainable growth may be spurred by global economic recovery, or by structural reform in Asia, he notes. In China a clearer sense of the direction of reform will come when leaders meet in November, says Swan, while in India next year’s election is likely to provide a catalyst. “If those reforms do not occur, and the global economy does not improve, Asian equity valuations will suffer.”
In terms of specific companies, he favours those that will benefit from structural reform and are less exposed to currency fluctuations, such as names in the internet and healthcare sectors.