The combination of a deteriorating macro picture in the US and an improving macro story in emerging markets will prove to be a tailwind for the asset class.
This is the view of Jean-Charles Sambor, head of emerging markets (EM) debt at TT International, who told FSA in an interview that global investors need to rethink their framework when it comes to EM debt.
Investors have been largely ignoring EM debt for the past five years because of the negative headwinds the asset class faced: including a wave of defaults in Chinese high yield, sovereign defaults in Africa and Asia, as well as a host of ongoing macro uncertainties.
EM debt as a result trades with a risk premium “because people have been quite traumatized by what happened over the last few couple of years,” Sambor said.
“Many market participants are still backward looking because it has been painful for the last five years, but when we take a forward-looking approach, we see no sovereign defaults in the next couple of quarters,” Sambor (pictured).
“So, you are likely to see a sharp improvement and a decline in emerging market corporate defaults while in the US, defaults are likely to go up.”
He believes that the emerging markets macro story is improving, especially in China, which will have a “significant impact” on the rest of the region, whereas in the US the macro situation is “deteriorating”.
“For the same credit risk you have much higher spreads in EM for much better fundamentals compared with the US,” he added.
“On top of that, EM debt is a massively under owned asset class and people will have to scale up their asset allocation. So, the technicals are also in its favour.”
Opportunity for active managers
Although Sambor is optimistic about the overall tailwinds, he warned that there will be some dispersion between individual issuers and therefore an active approach is needed.
“Some high yield sovereigns and companies are still misunderstood and mispriced,” he said.
“There are opportunities in the Middle East and Africa, and in Asia and China high yield where there is potential for significant spread compression or for some distressed names to perform very strongly.”
A decade ago, the consensus that gripped most EM debt investors was focused on the story of globalisation and a growing middle class within the region. Now, Sambor argued that investors should brace for volatility and increased geopolitical risk because it will provide opportunities for active investors.
“We are at the beginning of a new era where the US dollar is likely to weaken significantly, and there will be some capital flows back to emerging markets which will provide a relief rally to emerging market currencies.”
