Picking the winners
While big risks remain for emerging market bonds in 2016, Polina Kurdyavko of BlueBay expects active managers to find plenty of attractive prices.
Last year proved to be a challenging one for emerging markets and a volatile one for emerging market companies.
Growth continued on its lacklustre path in both emerging and developed economies, commodities trended lower, central bank policies continued to diverge and most emerging market currencies weakened significantly against the US dollar.
However, emerging market corporate debt held up relatively well, delivering a solid return in excess of 1% for the year.1 Both the more dependable investment grade credits and the more dynamic high-yield credits registered positive returns, outperforming their peers in both the US and Europe.
Now that the first interest rate hike by the US Federal Reserve is out of the way and the market has taken it largely in its stride, we feel that the move to higher interest rates will be slow and measured. That leaves US Treasury yields room to drift slightly higher.
On the other hand, headwinds in the emerging market corporate debt market mean spreads are likely to remain under pressure; however, we do not expect that pressure to detract meaningfully from the potential return of the asset class. (The high-yield segment of the market is currently yielding in excess of 10%.)
Falling oil and commodity prices are likely to further impact emerging markets in general, and companies in particular. We expect the resulting price falls to hurt companies in the metals & mining and oil & gas sectors. Both sectors are likely to suffer an increase in defaults. Overall, we expect the default rate to be around 5–7% for the high-yield section of the market for 2016, up from 3.7% in 2015.
However, we do not believe that we are in an emerging market crisis; rather, we feel we are nearing the point in the cycle where defaults should increase from the low base of the past few years to reflect the increase in leverage. However, we do not envisage them spiking to high double-digit figures like we saw in previous emerging market crises. In other parts of the market, we believe emerging market companies will continue to act prudently and to proactively manage their balance sheets through this period of uncertainty.
Like last year, we believe 2016 will be dominated by significant differentiation between the best- and worst-performing companies. The bouts of volatility that will inevitably come in the year ahead will give us the scope to take advantage of price dislocations and buy into fundamentally positive investment stories at attractive valuations.
We have seen first-hand the poor job that exchange-traded funds [also known as ‘passive’ or ‘tracker funds’] have done in delivering returns in these challenging environments, underperforming the indices by around 12% over the past four years. We believe the only way to navigate this market is through active management, with a strong focus on default avoidance and a capital appreciation mentality.
Past performance is not indicative of future performance.
The opinions expressed are those of Polina Kurdyavko of BlueBay Asset Management and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or by St. James’s Place Wealth Management.
1 JPMorgan Corporate Emerging Markets Bond Index (CEMBI) Broad Diversified