Kames Capital: Three sovereigns that stand out in the emerging market debt space
A number of emerging markets offer fixed income investors attractive longer-term returns thanks to a combination of the yields they offer and the prospects for their underlying economies, according to Kames Capital.
Emerging market debt found itself in the eye of the storm in the wake of Donald Trump’s election in the US late last year, with many investors cautious about allocating to regions which could be impacted by the regime change.
With his pro-growth agenda expected to boost the US dollar and raise yields across the fixed income spectrum, coupled with concerns over potential barriers to trade with certain countries, the view was that Trump’s Presidency would negatively impact emerging markets.
However, thanks to a combination of recovering global growth, stabilising commodity prices, and attractive yields, year-to-date the asset class has delivered positive returns, with JP Morgan’s emerging market hard currency sovereign bond (‘EMBI’) index returning 5.34% year to date*.
Theo Holland, co-manager of the Kames Emerging Market Bond Fund, said that across the emerging market spectrum there are a number of hot-spots offering investors attractive returns.
Below, Holland identifies some of the standout opportunities the region has to offer.
We recently participated in the new Sri Lanka dollar-denominated sovereign issuance. Priced at 6.2%, the B+ rated issue offered reasonable value versus peers. More importantly, Sri Lanka is an example of a good fundamental story in emerging markets at this time. Principally, the country entered in to an IMF EFF (extended fund facility) in April of last year, in which time it has made good progress restoring public finances from a number of structural standpoints. For example, inflation should be in the central bank’s range by the end of the year, with a primary budget surplus targeted by 2018. The current account deficit is also set to strengthen this year as trade barriers come down. Overall, we therefore believe that the country is on a path away from historically low tax revenues and high budget deficits. Its bonds, perhaps somewhat overlooked in the emerging markets universe, should perform well.
In expensive emerging Europe, Kazakhstan stands out as a good credit opportunity at this time. GDP growth in the final quarter of 2016 was strong, and the pick-up therein fairly broad-based. Early this year, the government’s decision to make a significant injection in to some of its troubled banks was a very welcome signal, after many years acting as a drag on the economy. The re-launch of the very large Kashagan oil field is significant for both the quasi KMG and the sovereign, and will support a further round of privatisations in Kazakhstan in coming years. Kazakhstan’s low government debt ratio and strong fiscal backstop give us confidence that it can navigate the challenges of commodity price volatility. Finally, and perhaps surprisingly, compared to regional peers its institutional strength is travelling in the right direction.
In Latin America, we believe the worst is past for Mexico. Better growth prospects and an improved fiscal position have led to a stronger than expected start to the year. At the same time, the risk of a disorderly renegotiation of NAFTA seems to be fading, as the true nature of its trading relationships become clear: Mexico’s exports to the States comprise a great deal of US value add, from under which it is unlikely that the US simply pulls the rug. A muddle through scenario, or possibly NAFTA 2.0 (with changes focusing on IP, selected sectors, and stricter rules of origin/national content), both feel more probable. Finally, quasi-sovereign Pemex has delivered solid first quarter results, albeit its turnaround has some distance to go. To this backdrop, Mexican debt is attractively valued compared to similarly rated peers, and while volatility cannot be discounted, we expect this value gap to close over the remainder of the year.