Readers will no doubt be familiar with the EM ‘grand narrative’ (eg. EM will surely outperform because of low debt levels, high growth, strong demographics etc). This note, is an attempt to bash away this EM ‘grand narrative’.
It explores what really have been the primary performance drivers of the three main investable subsets of EM debt (EM local currency sovereign, EM external sovereign, EM external corporates). It touches on themes I’ve previously written about on the risks to EM debt posed by Eurozone instability and the associated risks posed by a reversal of the huge decade-long portfolio flows that have supported the asset class. But the main focus of the note is on the sizeable additional long term risk posed to EM debt by the inevitable economic rebalancing of the world’s second largest economy – China.
EM debt is still ‘cool’ within the investment universe. However, it’s curious that people now say EM debt is a good investment ‘in the long term’, a subtle change brought about by the miserable performance of some EM countries over the past year. This miserable performance has been most notable within the BRIC economies* , where in recent months, the Brazilian Real and Russian Ruble hit three year lows against the US Dollar, the Indian Rupee hit a record low against the US dollar, and this year the Chinese Yuan has had the biggest drop against the US dollar since its big devaluation in 1994.
I’m not saying that EM debt will never offer good value; it’s important to stress that there is no such thing as a good or bad asset class, only a good or bad valuation. I’m simply saying that it’s important to understand the performance characteristics of EM debt, the risks facing EM debt appear to be rising, and while some exchange rates have begun to move, the asset class does not appear to be pricing in these risks.
Fashions rarely last – EM debt has been very trendy before, but favourable demographics and previously strong growth rates didn’t save emerging markets in 1981-3, 1997-98 and 2001-02. And Converse shoes haven’t always been ‘cool’ either – Converse had to file for bankruptcy protection in 2001 and ended up being bought out by Nike.
* Societe Generale’s Albert Edwards has amusingly and rightly described BRIC as a ‘Bloody Ridiculous Investment Concept’