Emerging-market debt not fairly valued, says Pictet

And even European high-yield credit is looking appealing at today's prices, argues senior product manager Alexandre Ris.
Emerging-market debt not fairly valued, says Pictet

Financial markets responded positively this week to Spain's newly announced tough austerity measures and the resolution of the UK's uncertainty over its future government. However, concerns remain over potentially poor future growth in the eurozone and its likely effect on developing countries such as those in Asia.

The €750 billion eurozone bailout announced last weekend means that all countries -- including the bigger economies such as France and Germany -- will have to carry out fiscal tightening, to avoid having to restructure their debt, says Alexandre Ris, senior product manager for the fixed-income range at Pictet Funds in Geneva.

Ultimately, the "huge amount of money on the table" must be financed and, as a result, the eurozone may record growth of 1% for the next five to 10 years, he adds.

A big question for investors is: Should they go into European fixed-income assets? "Current pricing is not reflecting the impact of these measures in the long run," says Ris. "So it will continue to be volatile. As long as the ECB [European Central Bank] intervenes in the market, we won't have fair value reflected in the market."

He suggests that investors should therefore focus on the credit markets in Europe. "The private sector is continuing to deleverage, and the current spreads in high-yield and corporate credit are very appealing," says Ris. "There won't be the same kind of performance we saw last year, but [they are attractive] from the carry perspective first, on the relative value to government second and because we think spreads will continue to tighten.

"We think this slow remediation phase will last for two to three years before spreads widen," he adds.

As for the impact this will have elsewhere, it seems inevitable that slower growth would affect emerging markets such as those in Asia. But Ris says Europe's debt issues "will not fundamentally affect any region other than Europe".

Moreover, now that money has been put down to stabilise this situation, there will be less risk aversion globally, he adds.

Assets across the board -- credit, equities, debt, commodities -- suffered in recent weeks, says Ris, but people are now looking again at the fundamentals of each asset class. He cites the Dubai debt problems in November, which caused extreme risk aversion globally for about five days. "But once Abu Dhabi put money in, everything settled down and asset classes started to recover on the basis of their own fundamentals," says Ris.

In terms of fixed income, the widening we've seen in spreads -- in high yield, investment grade and emerging-market hard-currency debt -- are much more appealing than they were two weeks ago, he adds. "Emerging-market hard currency has gone from 260 basis points over Treasuries to 300bp now.

"We're convinced that's not fair value; [spreads] will continue to tighten slowly to reflect improvements in emerging markets," says Ris. "[They] will tighten in the next 12-18 months to about 200bp."

For the next six to 12 months, he says investing in non-European government debt or European corporate/high-yield debt is "very appealing and very diversifying in terms of portfolio construction".

"Our main positioning right now is to be long credit, especially in financials -- there's still a lot of value there," adds Ris. "Not all European financials of course, as some are heavily loaded with Greek debt." As for high yield, he sees the biggest challenge as refinancing, but says the markets are open.

He says Pictet is particularly positive on emerging-market currencies -- on bond returns and currency returns -- taking the view that they are "heavily undervalued".

"There are currency-appreciation pressures, although emerging markets are trying to fight them," explains Ris. "But we will have to enter a re-evaluation competitive cycle. If China lets it happen, others will probably also do so."

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