2021: time to be ‘risk-on’ with equities and bonds
After a year like 2020, it seems almost foolish trying to predict what 2021 could hold in store. But...
With government bond yields in the developed world remaining historically low for the foreseeable future, the search to find alternative sources of income is unlikely to slow down any time soon.
One of those potential sources is emerging market bonds. But there are risks when investing in emerging economies, particularly with the global economy in a late-cycle scenario.
With this in mind, it felt a good time to get some insights from Charles De Quinsonas, the deputy manager of Elite Rated M&G Emerging Markets Bond fund.
“October 2019 marked the tenth time in a row that the International Monetary Fund (IMF) has downgraded global growth. This makes us slightly cautious on emerging markets because there has been a strong correlation between credit quality (the ability to pay back debt) and growth for the past couple of decades. That said, the IMF figures show emerging markets still offer stronger growth in 2020 (6%*) than developed markets – so we are not talking recession in emerging markets.”
“We continue to see value in local currency, so we will keep one third of it in the portfolio. In terms of positioning we are a bit punchy in Sub-Saharan Africa (15.2% vs. 7.7% for the neutral position**). We do not consider Sub-Saharan Africa as one region – it’s a lot of different countries with totally different dynamics. Nigeria and Ghana are oil driven for example, while Kenya, Benin and Ivory Coast are not – so we have to look at each country and each bond in isolation.
“We are also optimistic on Ukraine, where we like the reform momentum. The president, Volodymyr Zelensky, is a former comedian, but the difference between him and others is he is honest enough to admit he does not have a grasp of economic matters and, as a result, has surrounded himself with good people. Zelensky has a good reform agenda, which the IMF is supportive of, and he has a vast majority of parliament behind him.
“China is the principal reason we are underweight Asia, as we are not getting paid for the valuations. We do, however, have exposure to frontier markets like Sri Lanka. We are also still underweight South Africa and Turkey as we feel the story in both countries is deteriorating. We are also wary of the unrest in Lebanon.
“The spirit of the fund is to have as much diversification as possible. It’s very tempting in emerging markets to hold very high yielding countries due to strong conviction – but you never quite know what may happen. Diversification in country and company position size is essential from both a fundamental and liquidity standpoint.
We’d always prefer to be invested in the smaller Latin American countries or frontier markets in Asia that are improving, rather than some of the bigger countries if we think their credit quality is falling.”
“Trade wars are here to stay, regardless of whether there is a deal or not. If Trump strikes a deal – which he probably needs to be re-elected – that doesn’t mean that he won’t change his mind after the election, something he has done before. If you put yourselves in the Chinese’s shoes – why wouldn’t you wait 12 months just to see if another President can strike a deal? Populism across both developed and emerging markets is here to stay and that has an impact on growth, hence our caution.
“Where we are less cautious is on corporate earnings and the credit side of corporate bonds and corporate issuers in general. People who have invested in our portfolio for a while will know we have been reducing corporate debt and adding sovereign debt – but now the corporate bond sector is more attractive in terms of metrics and trends.”
*Source: IMF World Economic Outlook October 2019
**Source: M&G, 30 September 2019