When Kristin Ceva, CFA, managing principal and head of emerging market (EM) debt strategies at Payden & Rygel, began analyzing emerging market bonds in the early 1990s, there were 14 countries in the dollar-pay index. Today there are more than sixty countries in the index, with $1 trillion in dollar-pay bonds, $1.1 trillion in EM corporates, and $7.9 trillion in local currency debt.
“There are many attractive bonds to choose from, and emerging markets do not trade as a monolith,” Ceva said. At the same time, average bond quality has increased across the board due to healthy increases in foreign exchange reserves and improvements in debt sustainability, lower leverage, and better fiscal dynamics. “Emerging countries have half the debt and half the debt-to-GDP ratios of developed countries,” said Ceva, making their bonds increasingly attractive to long-term investors like pension funds and insurance companies.
History has shown that as growth in developed countries improves, EM economies will benefit. In 2014 and beyond, Ceva expects EM countries to continue to achieve higher growth rates than developed countries, even though differentials have narrowed somewhat.
Two major risks could throw emerging debt markets off track — rising interest rates in the United States, and the EM electoral cycle. “We do not think the US macro outlook — Fed policy, growth, and inflation — points to an imminent and meaningful rise in interest rates,” said Ceva. “EM currencies have been under depreciation pressure over the past two years, and could still weaken due to Fed Tapering, although spot levels are close to the 2008 financial crisis lows, and valuations have improved,” she noted.
EM electoral cycles bring both risks and opportunity. On the positive side, elections represent the voice of the people, “and a growing middle class in emerging market countries are demanding better services, education, and cleaner government,” Ceva said.
Ceva gave the audience an around-the-world tour of the countries, markets, and sectors that she and her team find most attractive today. She favors countries with new reforms in place and strong macro frameworks. “High [private] investment and moderate government spending are the ideal combination,” Ceva said. “We also like countries that are ‘institutionalizing’ their macro frameworks for the longer term.”
Countries in Latin America that fit this optimal combination today are Chile, Colombia, Peru, and Mexico. In addition, one of the most promising sovereign credits in Central America is the Dominican Republic, with its recent fiscal reforms, strong GDP per capita, and growth averaging 5% since 2000.
Turning to Mexico, “perhaps we are entering the ‘Mexico Moment’ as Brazil’s star fades,” said Ceva. Aggressive reforms implemented by Mexico’s Peña Nieto administration in labor, education, politics, and core corporate sectors are expected to lift the country’s medium-term growth (as forecast by the IMF) to 3.5%–4% in 2014. Mexico does have more work to do on such governance issues as rule of law, control of corruption, and political stability, however, Ceva noted.
Another attractive EM debt security are “quasi-sovereign” bonds that offer opportunity in attractive countries like Mexico where energy reforms are expected to benefit the state-owned oil company, Pemex, or Colombia’s state-owned oil company, Ecopetrol, whose government opened markets in early 2000. Certain corporate bonds in Latin America look attractive as compared to peers in the developed world. For example, TELEFO bonds in Colombia look stronger than similarly rated bonds like T-Mobile and Sprint in the United States on an OAS basis with less leverage.
Indonesia’s dollar-pay sovereign debt looks attractive relative to its BBB peers worldwide, including Brazil, Turkey, South Africa, and Panama. Though further progress on structural reforms is needed, expected growth in Indonesia is nearly 6%, and it has a much lower debt-to-GDP ratio and smaller current account deficit than its peers. “Indonesia is attractive on the dollar-pay side, and we’ve been adding local currency debt as well,” Ceva said.
With an election coming up, “India’s improvement in 2014 will be more nuanced,” Ceva said, but she has observed progress in structural reforms, monetary policies, and reduced current and fiscal account deficits. Ceva highlighted that India’s neighbor Sri Lanka is an upgrade candidate, and local government bonds continue to be attractive because of the country’s successful monetary and currency policies since 2012.
In Central and Eastern Europe (CEE), export markets have improved with the recovery in Germany and funds have flowed into CEE debt and out of European peripherals where spreads were tight. In the CIS, Ceva likes Armenian Eurobonds because of the country fundamentals, the quasi- sovereign bonds of SOCAR, the state-owned oil and gas company in Azerbaijan, and credits of oil-producing companies in the Kashagan oil field in Kazakhstan.
Recently, with the conflict in Ukraine, Ceva is watching capital outflows from Russia ($50 billion in recent months). For now, the country’s liquidity cushion of about $500 billion in foreign exchange reserves seems sufficient to satisfy investors and prevent capital flight. “With everything going on in Russia, investors have a hard time selling because of Russia’s strong liquidity cushion,” said Ceva.
Moving on to Africa, Ceva agreed this could be “the African Century.” “This is a very interesting region for fixed-income investors in terms of diversification and new supply,” Ceva said. The trend in African demographics is positive, with the median age in the region at 19 years (versus 29 years in Latin America, 30 years in Asia, 37 years in America, and 41 years in Europe). Only three African countries’ populations are in the top 20 today, but by the year 2100, 10 will be in the top 20. “When you compare Africa to the Middle East, African bonds are trading on economic risk, not political risk, which makes the bonds easier to discount.” As a result, Ceva has taken on more African positions in Nigeria, Tanzania, and the Ivory Coast.
Strong risk measurement and management practices are of course critical to managing emerging market debt portfolios. “We have risk parameters for position sizing and portfolio diversification including both absolute and relative limits as well as contribution to duration maximums. We look at diversification by country, by asset class, and by ratings and set position limits on the more illiquid sectors and currencies,” Ceva said.
Given Ceva’s successful career and long experience with an asset class that has come of age, investors are taking note. She knows what it takes to survive and thrive in these fascinating markets.
Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.
Photo credit: W. Scott Mitchell