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How would you summarize 2023 for Emerging Markets Debt?
We think emerging market debt has seen two stories unfolding through the course of 2023. On one hand, we've seen a lot of macro uncertainty given the uncertain outlook on growth and inflation, which translated into risk-free assets, i.e. US rates, being one of the most volatile assets. But on the other hand, we've seen continuous improvement in emerging market fundamentals, including a much more hawkish stance from the central bank governors that has been consistent over the last three years, which ended up driving inflation down to single digits in most emerging market countries for the last 12 months, combined with very tight fiscal stance. And yet, while we're seeing this gold deluxe, if you will, on monetary and fiscal policy, we're also seeing growth being very resilient in emerging markets, with this year and next year forecasts being close to 4%, which is not being affected by the broader global slowdown.
What is your outlook for Emerging Markets Debt in 2024?
We're quite constructive on the asset class. And that's because even though we've seen a fundamental, I would say, if not improvement, then resilience of the asset class, we're starting the year with a higher level in yields than we finish the year, and in some sub-asset classes, high levels in spread as well. So we do feel that, as a starting point, 2023 offered us an interesting entry level from a valuation perspective into the asset class, and potentially could give us an opportunity to generate double digit returns if all the stars are aligned for the asset class.
Where do you see opportunities in Emerging Markets Debt?
As fixed income in an asymmetric asset class, with the coupon being the return and the principal loss being the downside, we feel that the opportunity in emerging market debts starts with a very high level of yield, and yet very low expectations for default. Next year we expect close to zero default in the sovereign debt, and mid-cycle default on the corporate debt, and yet the level of spreads and yields that we're starting the year with are elevated. When it comes to risk, I would split them in two camps. Firstly, it's the macro-related risks, and really here it comes down to the core rates volatility. If we don't see the Fed starting to cut as soon as the market expects, we're likely to see risk assets more broadly being on the back foot, as we've seen in some instances this year. The second part of the risk is fundamentally driven, and that really comes down to broadly commodity prices. That's why, in terms of our positioning, we prefer to be in the higher quality names that have commodity linkages, both on the sovereign and corporate side, rather than high yielding names or higher risk names, given the uncertainty on the commodity prices into next year. Last but not least, in our view, geopolitics will continue to dominate newspapers' headlines, but it's unlikely to have a meaningful impact on the performance of the asset class through the course of 2024.
Summary Points:
Emerging market debt currently offers one of the highest yields in the last 13 years at the index level– through a combination of higher rates and wider spread. This offers an exciting opportunity for investors.
Fundamentals are improving for EM countries. Not only is the growth expected to exceed that of Developed market countries in 2024, many EM central banks have followed an orthodox monetary policy path leading to inflation being moderated.
The high commodity prices have also led to improvements in fiscal and current account balances in many countries leading to better credit profile.
Defaults are likely to come down from their peak in 2022 and settle closer to historical averages.
The volatility is expected to come from two main sources – core rates and geopolitics.
But in geopolitics it is worth remembering that only a handful countries are directly affected by war and even fewer by potential flashpoints in Asia.
Away from these there are many EM countries which are healthy, growing and offer very attractive yield. Investors should capitalize on them through active portfolio construction.