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EM local currency investing

Investor risk appetite brings new players to an expanding opportunity set

Emerging market debt saw record inflows across 2016 and 2017 as income seeking investors sought higher returns in reaction to the bleak yield landscape across much of the developed market (DM) universe.

Local-currency denominated assets did particularly well in this context, with the JPMorgan GBI-EM Global Diversified index returning 25% from February 2016 to December 2017. This relatively new asset class is rapidly expanding from a base of around 17 markets, presenting, in our view, a number of interesting developments for investors from both return and diversification perspectives.

Holding restrictions around China’s local bond market were eased in 2016 with the launch of the China Interbank Bond Market scheme (CIBM). BlueBay is at the forefront of CIBM developments, being one of the first institutions worldwide to be granted a license to access the market to-date. At an excess of US$ 7 trillion in size, and with foreign investors currently holding only around 5% of this, the opportunity set appears very attractive to us.

Argentina has also expanded its debt offering, having implemented a programme of striking political and economic transformation. Now readily accessible to the international investment community, Argentina’s attractive yields make it one of the gems of the EM debt universe.

Egypt is another market that has gone through significant reforms, following the military coup in 2014. Aided by IMF support and efforts to de-peg the Egyptian pound, our rigorous on-the-ground due diligence has highlighted select pockets of opportunity.

We believe tactical trade potential is also present in Nigeria, when approached using detailed due diligence processes to counter economic and corporate governance challenges.

The local currency corporate debt market is an area of increasing interest within the emerging market (EM) universe. For mainstream EM countries, which have an established local currency sovereign market and seasoned local currency benchmark curve, we have seen a rising number of corporates seeking to take advantage of an investor base willing to increase their tactical allocation to this sub-sector.

This rapidly expanding opportunity set leads an investor to re-examine the structural case for local currency debt. In our view, the local currency market rally witnessed over the last 20 months has been firmly rooted in fundamentals, and further aided by broader risk-on sentiments towards emerging markets. We believe there are a number of factors that put EM local currency debt on a firmer footing today, potentially paving the way for a multi-year recovery, some of which are:

  • A combination of higher growth and lower inflation
  • Improved current account deficits
  • Attractive real and nominal yields
  • Cheap valuations of EM currencies

As fixed income investors, we are very mindful of the risks facing this asset down and we would highlight three core risks:

  1. G3 central bank balance sheet reduction
  2. China leverage build up
  3. Busy election calendar and increased geopolitical risk

On balance, the positive structural case for EM local currency debt should outweigh periodic corrections within the asset class. Our bias would be to add on weakness to take advantage of the positive structural story.

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Special topic

Nick Shearn

By
Nick Shearn
Senior Portfolio Manager
Som Bhattacharya

By
Som Bhattacharya
Institutional Portfolio Manager
Published 15 January 2018
Download article here.
10 minute read
 

 

This document is issued in the United Kingdom (UK) by BlueBay Asset Management LLP (BlueBay), which is authorised and regulated by the UK Financial Conduct Authority (FCA), registered with the US Securities and Exchange Commission, the US Commodity Futures Trading Commission (CFTC) and is a member of the National Futures Association (NFA). Past performance is not indicative of future results. All data has been sourced by BlueBay. To the best of BlueBay’s knowledge and belief this document is true and accurate at the date hereof. BlueBay makes no express or implied warranties or representations with respect to the information contained in this document and hereby expressly disclaim all warranties of accuracy, completeness or fitness for a particular purpose. This document is intended for “professional clients” and “eligible counterparties” (as defined by the FCA) only and should not be relied upon by any other category of customer. Except where agreed explicitly in writing, BlueBay does not provide investment or other advice and nothing in this document constitutes any advice, nor should be interpreted as such. No BlueBay Fund will be offered, except pursuant and subject to the offering memorandum and subscription materials (the "Offering Materials"). If there is an inconsistency between this document and the Offering Materials for the BlueBay Fund, the provisions in the Offering Materials shall prevail. You should read the Offering Materials carefully before investing in any BlueBay fund. This document does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product in any jurisdiction and is for information purposes only. No part of this document may be reproduced in any manner without the prior written permission of BlueBay Asset Management LLP. Copyright 2018 © BlueBay, the investment manager, advisor and global distributor of the BlueBay Funds, is a wholly-owned subsidiary of Royal Bank of Canada and the BlueBay Funds may be considered to be related and/or connected issuers to Royal Bank of Canada and its other affiliates. ® Registered trademark of Royal Bank of Canada. RBC Global Asset Management is a trademark of Royal Bank of Canada. BlueBay Asset Management LLP, registered office 77 Grosvenor Street, London W1K 3JR, partnership registered in England and Wales number OC370085.

Published January 2018