Analysts had been banking on 2020 being the year emerging markets would stage a comeback after a lost decade of returns following the financial crisis in 2008. But then the coronavirus pandemic hit.
Like most investors, M&G Emerging Markets Bond manager Claudia Calich was shocked by the speed and severity of the downturn compared with the global financial crisis.
“From an investor standpoint, you either reacted very quickly on the first or second day, or the best course of action, if you didn’t do that, was really to ride it out, which is ultimately what we ended up doing,” Calich says. “The fund went into the red for a few months. But since April, we’ve been on a gradual steady recovery.”
During the past year, the M&G Emerging Markets Bond has lagged behind its peers in the IA Global EM Bonds Blended sector, returning 1.2% against the sector’s gains of 2.9%.
But on a three- and five-year view, the $1.1bn (£840m) fund is first-quartile. Since Calich took the reins in 2013, she has returned 78.3% in sterling terms, compared with the sector’s 40.2%.
Although the economic fallout from the coronavirus pandemic has been devastating, particularly for emerging markets, Calich has seen these countries bounce back from bleak times before.
Light at the end of the tunnel for emerging markets after Covid hit
Growing up in Brazil in the ’70s and ’80s, she witnessed her home country plagued by periodic economic crises, hyperinflation, currency depreciation and bank accounts being frozen. This “partially terrorised … but also fascinated” Calich so much that she ended up moving to America to pursue a degree in economics. She continued her studies in Japan, obtaining an MA degree in international economics from the International University of Japan in Niigata.
“I was trying to get a better understanding of how things became so messy and why Brazil was such an exception and different than other countries,” she reflects.
Throughout the ’90s, Calich worked at several firms as an emerging markets analyst with a focus on Latin American debt, including Standard & Poor’s, before landing at Oppenheimer Funds in New York in 1999.
Covering Latin America bonds while the region was in the throes of a debt crisis is an experience Calich says was extremely beneficial for her career. “You get thrown into the fire,” she says. “It doesn’t get more difficult than that type of environment.”
Now at M&G with nearly three decades of experience under her belt, including almost 10 years as Invesco’s head of emerging market debt, she is relatively sanguine on the recovery of emerging markets.
“I think there will be light at the end of the tunnel; it’s just that the tunnel will be longer for some economies versus others.”
US election sparks local currency rebound
Momentum from the US election has provided a glimmer of hope. News of Joe Biden’s win coupled with game-changing results from Pfizer, Moderna and Astrazeneca on their Covid-19 vaccines has fuelled a recovery in emerging market currencies. The Brazilian real is up 11% against the dollar since 3 November, while the Mexican peso and Russian rouble have shot up 3% and 4%, respectively.
Calich’s local currency position had reached as low as 15% during the worst days of the Covid sell-off but now is back to a neutral allocation, representing a third of the M&G Emerging Markets Bond Fund. Here she has been adding to Egypt, as well as Russia and Mexico, currently her two largest positions at 3.2% and 3.1%, respectively.
Mexico is one of the countries Calich feels will benefit the most from a US recovery, having signed the US-Mexico-Canada Agreement, a replacement for the North-Atlantic Free Trade Agreement.
Calich has also been reducing her underweight to the South African rand. While the country still finds itself in a challenging economic situation, valuations at the long end of local currency bonds are too good to pass up.
“It’s rare now we can see yields in the high single digits or, in the case of South Africa, the low double digits,” Calich says.
“The absence of a ‘blue wave’ means there’s not going to be massive amounts of fiscal expansion or pressure on the US Treasury curve, which just increases the relative attractiveness of higher-yielding assets such as South Africa.”
In the short term, Calich doesn’t see Biden’s win as much of a game changer for emerging markets. “I think it’s probably safe to say that there will be a bit more of a focus on not stirring the pot much and basically focusing energy on the domestic economy and Covid-19,” she says.
As such, she doesn’t expect to see further US economic sanctions imposed on Russia and thinks China will probably be better off in the very near term.
Neither does she expect to see massive changes in America’s immigration policies that would impact central American countries, even though “there will be rhetoric change for sure”.
Further down the line things could get more “nuanced”, she admits. A Biden administration could prove a rude awakening for Brazilian leader and Trump favourite Jair Bolsonaro, given the president-elect’s stance on climate change, which Bolsonaro has denied exists.
“Is that enough to change asset prices? I would say probably not,” says Calich. “I’m not expecting any drastic action, such as sectoral sanctions or anything like that happening toward a country like Brazil.”
Tensions between the US and China are not going to dissipate either with Biden in charge, she adds, with the incoming president likely to continue to spar over technology and intellectual property issues.
Still pockets of value in frontier markets
Structurally, the M&G Emerging Markets Bond has quite a bit of exposure in frontier markets and lower-rated credits.
At this point, spreads on investment-grade assets are back to pre-Covid-19 levels whereas in the high-yield markets there is quite a bit left, “reflecting in some cases a tougher macroeconomic environment,” Calich says.
Argentina is one lower-rated country she likes. Bonds were recently trading as low as 30 cents on the dollar, which Calich says is “very cheap”, considering the country successfully restructured nearly all its $65bn of debt and avoided a messy default. Since the beginning of the month, they have gained over 10%.
In sub-Saharan Africa, Calich together with her team, which includes deputy manager Charles De Quinsonas and three other strategists, have been discovering pockets of value in countries including Côte D’Ivoire, Senegal, Rwanda, Benin and Kenya.
All five countries have experienced high levels of growth during the past few years and have proven more resilient during 2020 than many other parts of the world, with most still forecast to deliver positive growth this year and see a sharp rebound in 2021.
“We feel some have been punished by the market too much and that flows have not yet come back to that part of the market,” she says.
One area where she has reduced her exposure recently is Ethiopian bonds. In addition to challenges arising from the pandemic, the country is currently in the grip of a brutal domestic clash between forces loyal to the federal government led by prime minister Abiy Ahmed and the Tigray People’s Liberation Front.
At this stage it is too tough to predict whether the conflict will escalate and how long it will last, which is why Calich cut exposure in the fund from 0.4% to 0.1% in the past month.
“The bonds were trading still very close to par, so there was limited upside versus the potential downside if things got much worse.”
Virtual treks
One thing Calich has missed the most during 2020 is travel. Ordinarily, she visits a handful of countries each year for work, last year trekking to Argentina, Chile, Uruguay, Peru, Hong Kong, Singapore and the US.
But, thanks to Covid-19, travel to far flung corners of the world has been replaced by “virtual trips”.
A month ago, she attended the International Monetary Fund’s annual conference, normally held in Washington DC, where she sat in on dozens of meetings with government officials and issuers all without leaving London.
“It’s not the same for sure,” Calich admits, “but it definitely bridges the gap for now and is still absolutely useful.”
