DFMs are predicting a resurgence of investor interest in emerging markets with China’s economic recovery and Joe Biden’s presidential win fuelling hopes of a strong rebound from the coronavirus crisis.
Sentiment toward emerging market debt has remained net positive over the past 12 months among UK and European fund buyers compared with gilts and developed market govvies which have remained out of favour, according to Last Word Research.
A similar number of UK and European fund buyers wanted to increase or hold their exposure to emerging market govvies and corporates in Q3, though in Europe there was a slightly higher proportion of investors who wanted out.
Muzinich & Co portfolio manager Warren Hyland notes the shift of inflows into emerging markets at the start of September accelerated in October.
His team believes investors and allocators currently have more interest in emerging markets than they did in H120 for three main reasons, namely, better growth, no liquidity issues and good market sentiment.
China recovery has knock-on effect for LatAm and Middle East
“Emerging markets are currently attractive to investors because they seem to be recovering from the coronavirus and are showing high growth,” Hyland says.
“China’s sequentially strong growth numbers has, in fact, surpassed its pre-Covid-19 levels, working at full speed again. The International Monetary Fund has recently estimated that China’s contribution to global GDP growth will increase to 26.8% in 2021.
“This has had a secondary knock-on effect on the Asian region and in the commodity sector in Latin America and the Middle East, which has led to increased confidence for emerging markets.”
Hyland adds that growth areas, such as trade and manufacturing “are back to normalised levels, and economists and forecasters predict that emerging markets will grow faster than western markets and recover more quickly”.
Less interest-rate correlated
Dimitry Griko, chief investment officer, fixed income at EG Capital Advisors, says when it comes to emerging market debt that “valuations look very attractive versus other asset classes that have rallied quite significantly since the peak of the Covid crisis”.
“Pockets of value still exist and look even more attractive given the expectations of a more pronounced economic rebound within emerging markets next year.
“Hunt for yield and diversification away from developed market risks continue to support emerging market debt. Uncertainty about interest rate reaction economic rebound in 2021 attracts investors to less interest-rate correlated subclasses; such as emerging market corporate high yield, which tend to perform better during periods of economic growth.”
See also: DFMs weigh up EM debt exposure as issuance hits record high
Emerging markets will benefit from Biden bump
Though liquidity is a concern when it comes to emerging market investing Hyland says, compared to 2008, “the current Covid-19 crisis is not a banking crisis and the banking system is fully operational and providing funding for corporates and sovereigns”. “Thus, emerging market countries are able to fund themselves during the crisis.”
Hyland and his team also think emerging markets will benefit from a Biden bump on the basis the president elect is expected to be “less confrontational on trade” than Donald Trump.
“Furthermore, it is expected that a Biden administration will be much more generous with fiscal spending than the Republicans,” Hyland adds.
“Therefore, the US will have more to spend and will buy more goods from emerging markets. As US debt rises from fiscal looseness, an investor must be compensated, which is usually through yields and Treasuries which have been set by the central banks.
“The only other way to do this is through a weaker currency. The weakness in the US dollar is typically seen as a strong sentiment driver for the emerging market asset class”.
Economic rebound expectations
For EG Capital Advisors’ Griko, “the corporate space overall looks extremely interesting”.
“Over the past couple of years, we have seen divergence of sovereign risk from corporate risk with quite a lot of the latter often being safer and less dependent on the macroeconomic picture.
“This year’s flows support that, and we expect the trend to continue,” he says.
“Riskier, lower-rated corporates are looking much more attractive on the risk-reward basis. The recent rebound from the Covid selloff has not been as pronounced as it was in higher quality names with investment grade spreads being close to historic tights.
“Meanwhile, high yield is still close to historic wides, leaving a lot of potential for catching up.”
When it comes to what the landscape looks like for emerging market debt in 2021, Griko says, “given the expectations of an economic rebound, strong bids are bound to continue supporting the market throughout the next year”.
“However, until we fully know the damage done by the pandemic, security selection and risk management are going to be key.”
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