Global risk aversion hits emerging market debt

Emerging market debt is being hit by global risk aversion and political distress in high beta areas such as Brazil, Turkey and Venezuela, says Guido Barthels, global head of debt research at Dresdner Kleinwort Wasserstein.

Barthels believes the main driver of emerging market debt at present is the situation in Brazil rather than global macro or market themes.

He says: 'Despite being hit by a combination of risk aversion and country-specific fears, emerging market debt has held up well compared to other credit classes across the rating spectrum. Indeed, it looks as though high-grade emerging market debt has benefited from the flight to quality more than high-grade corporate America.' Barthels notes that Dresdner's emerging market macro and market views are qualitatively unchanged. The group expects the emerging market credit curve to flatten once again as Brazil risk recedes in the third and fourth quarters, he says.

In the short term, Barthels admits Brazil risk could drive spreads on emerging market debt significantly wider. However, he says perceived refinancing risks in the country have become excessive and there seems little chance that major political or policy changes will emerge.

Geoff Blanning, head of emerging market debt at Schroder Investment Management, says the performance of the sector is closely aligned to the economic performance of emerging countries. Therefore, he says, it is also sensitive to factors such as world growth and sudden shocks to the global economy.

Nonetheless, Blanning believes the market is more mature than it was in 1998 and is dominated by longer-term investors such as pension funds and insurance companies.

He adds: 'Indonesia is currently one of our favoured countries. Recent government policy initiatives have been impressive and economic trends are good. The rupiah's strong showing will accelerate anticipated interest rate cuts, supporting our position in domestic bonds.

'Philippine domestic government bonds, yielding 15%, should also make handsome gains. This is a true emerging bond market that should benefit from wider distribution in the coming year. Elsewhere in Asia, recovering global growth is a positive for most Asian credits and currencies.'

Barthels says the Philippines is still showing strength, with low beta and regional diversification continuing to tighten spreads.

He adds that the Asian primary market is unable to support demand, leading to all new issues being continually oversubscribed.

Dresdner is raising its year-end emerging market spread target to 600bp from 550bp and is reducing US dollar driven currencies in favour of Europe-linked emerging market currencies, he notes.

'Our core views remain unchanged and we continue to advise a balanced portfolio that offsets high beta with low beta, low financing need and liquid sovereigns,' says Barthels. 'We have a major overweight position in Russia and are moderately overweight in Brazil, underweight in Venezuela and hold market positions in Mexico and Turkey.'

Adam Lewis

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