From Kenya to Brazil to Egypt – opportunities in emerging market bonds

The rhetoric surrounding possible trade wars with Mexico and/or China, alongside a rising US dollar and US government bond yields following the election of Donald Trump has, quite understandably, raised a few questions over the outlook for emerging market bonds.

But emerging markets are plentiful, with each country possessing unique macroeconomic drivers. From Kenya to Honduras, Jamaica to Egypt, the diversity makes it a great stomping ground for an active fund manager. We asked Richard House, manager of Elite Rated Standard Life Investments Emerging Market Debt fund, where he is currently investing.

“The emerging market debt universe is much more resilient today than it was back during the ‘Taper Tantrum’ of 2013,” he says. “Since then, many major emerging market countries have undergone sustained external account rebalancing, aided by a period of uninterrupted exchange rate weakness that ended at the beginning of 2016. Because of this, external financing needs have dropped sharply, and there is a greatly decreased reliance on foreign capital markets.”

Richard bases his investment approach on fundamental, top-down analysis of each investable country. He believes this allows him to understand the macroeconomic direction of travel of each country and to identify which are improving and which are deteriorating. When there is a divergence between his analysis and what is reflected in asset prices, he looks to exploit this opportunity by taking high-conviction positions.

“Indonesia is a country we view as being on an improving trajectory,” he says. “This is thanks to better terms of trade, a pick-up in activity driven by increased infrastructure spending, favourable inflation dynamics and stable fiscal trends.

“Such a broad-based improvement in its macroeconomic drivers has allowed Indonesia’s bonds to perform strongly over the past 12 months. We also see Brazil as offering value as it comes towards the end of a difficult few years at both the political and economic level. With a new market-friendly government and a domestically-oriented economy that should be relatively sheltered from policy decisions made in Washington DC, we believe Brazil will move onto a more positive trajectory in 2017.

“At the other end of the spectrum, we believe that what we don’t hold is as important as what we do hold and we are comfortable having no exposure to an issuer regardless of its representation in a benchmark. Indeed, we have long held a negative view of Turkey. Not only does it display elevated levels of political uncertainty but, being highly dependent on external financing to service its debt, Turkey is particularly vulnerable in a rising rate environment.

Richard concludes: “Emerging market bonds continue to pay a reasonable level of income and add a lot of diversification to a portfolio. At a time when broadly improving fundamentals and still-attractive valuations are intertwined with heightened uncertainty, we believe a high conviction, macro-driven country selection approach offers the best means of delivering meaningful outperformance from a genuinely diverse asset class.”