The local currency emerging market debt market is currently having an “exceptionally long period of underperformance”, according to Simon Lue-Fong, Pictet AM’s head of emerging market debt.
“We are going through unusual times. Ten years ago, the local currency emerging market debt tended to experience violent cycles, characterised by booms and busts. But even back then, those downturns were fairly short. There would only ever be one year of decline and that would be followed by a rally,” Lue-Fong said.
The most recent downturn, however, has been characterised by “three consecutive years of market falls”.
“The duration of the decline has caught out many investors: they have tried to pick the bottom of this cycle too early and are now getting frustrated,” he said.
Emerging market currencies have been weak because growth has been unusually sluggish, he said.
“Between the early 1990s and 2012, emerging economies in general posted below-trend growth rates for periods of between two to six quarters at most. But now, they’ve been growing below potential for 15 consecutive quarters, according to our economists’ model.”
However, this downturn is unlikely to end soon, he said.
“We are still not seeing sufficient economic strength. I can’t see where growth is going to come from in the short term. There don’t seem to be either domestic or global triggers. Emerging market countries are largely constrained by how much monetary or fiscal stimulus they can generate – that, by the way, is why their currencies are taking all the strain of economic adjustment.”
Spots of value in the market
Even if the picture is not particularly encouraging for emerging market debt in general, Lue-Fong said there are some spots of value in the market.
“There are parts of Southeast Asia that look interesting, like Vietnam. That is a country that has largely solved its credit, banking and housing problems. It is an up-and-coming story, but it doesn’t have a lot of tradable debt at the moment,” he said.
Elsewhere, he believes Latin America looks exciting.
“There’s been a lot of political turbulence over the past few years, but turbulence creates investment opportunities.”
For example, Argentina now has a technically proficient government determined to get inflation down to 5% by the end of 2018, from 40% currently, he said.
“I don’t think they are going to do it, but even if they get halfway there, it would be a massive success. Earlier this year we bought some of their treasury bills. Obviously it’s risky, but at one point that debt was yielding around 38%. There was so much demand that it started driving the currency up, and forced the government into trying to limit purchases from foreign investors.”
In addition, Brazil has its problems, but it too could be heading towards a technocratic government and to where Argentina is now, he said.
“There are opportunities out there. But it’s no longer how things were in the bubble days when everything was rallying on liquidity and it didn’t matter what you bought. Now, differentiation is crucial and it is probably going to remain a key feature of our investment,” he added.
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The Pictet Emerging Local Currency Debt Fund has been mostly underperforming its benchmark — the JPM GBI-EM Global Div Composite Index — over the past three years, according to FE Analytics.
