Our conclusion? Ultimately, it is fundamentals that will drive long-term returns, so we’ve been selecting various countries that we believe have good long-term potential based on their individual fundamentals, including good current account balances, appropriate monetary policy and strong growth prospects.
Different region, same question
A common question we have heard from clients during our visit to Tokyo is similar to what we have heard in Europe and in the US: investors are asking how they can better manage their bond portfolios in an environment where interest rates are moving higher.
Our approach today is to position very defensively with regard to interest rates; we are actively allocating across different currency markets to potentially generate positive returns in an environment where interest rates go up. We believe it absolutely necessitates being active, and it absolutely necessitates being global. We are looking for opportunities to earn a decent yield without taking a lot of interest rate risk.
And we think countries like South Korea and Mexico, with strong underlying fundamentals, are places that may offer a solid and positive real yield without taking a lot of interest rate exposure.
Japan’s liquidity pump
Japan is actually one of the most important places to be in, and focus on, to understand the global impact of the US Federal Reserve’s tapering of its asset purchase program in a global context. Even though the Fed has started to taper, at the same time, the Bank of Japan is embarking on a massive amount of QE.
So while the Fed will not likely print an additional trillion dollars, the BOJ is in the process of printing the equivalent of an additional trillion-plus US dollars. Given BOJ policy, I think the amount of global liquidity should be adequate to support capital flows across the global economy and maintain the global recovery that’s underway.
We expect the Japanese yen to depreciate, and the yen versus the dollar is one of the areas where we’re seeking to add alpha. One of the core components of our currency strategy is long the dollar, short the yen.
Emerging markets: not all the same
The important thing to understand is they are not uniform. What is happening in a country like Turkey is completely different than a country like South Korea. The dynamics that drove some concern in places like Turkey – such as current account deficits, fiscal deficits, monetary policy that was inappropriate – are not representative of the entire asset class.
Many countries, including Malaysia, Hungary, Poland and Mexico, in our view, are well positioned to deal with any changes in Fed policy, given strong current account positions, solid growth, and monetary policy that is proactive and ahead of the curve. As such, we viewed the market volatility over the last couple of months as an opportunity to take advantage of the fact that the market was not differentiating based on fundamentals and was treating the entire emerging markets asset class uniformly. As a result, we were able to exploit some of the market panic and feel that we are well positioned to take advantage of the dynamics going forward.
So in sum, this period of volatility that we’ve seen over the last several months is not different from periods we’ve seen over the past several years. It has been characterized by panic, and it has been characterised by lack of understanding of the differentiation between countries.
And we are doing what we’ve always done, which is to go out to these countries, understand the underlying fundamentals and exploit these periods of panic. As we look into 2014, we are excited about the potential opportunities in many countries around the world.
For Michael's specific views on China, look at www.portfolio-adviser.com tomorrow (25 April)
