The environment still looks favourable for emerging market bonds, with managers highlighting in part...
The environment still looks favourable for emerging market bonds, with managers highlighting in particular the Latin American and emerging European markets. But there are problems looming, with Latin America threatened by a potential sell off of US treasuries, and emerging Europe by a failure to implement the new constitution.
According to Zsolt Papp, senior economist at ABN Amro, it is a good environment for emerging market bonds in Brazil, Turkey and Russia. He feels these countries are stable in terms of economics and politics and their inflation policies are under control.
Papp favours long-dated government bonds in Brazil as the yields are very attractive at around 9.5%. He warns of the danger of a global US treasury sell-off, although he feels the more likely outcome is that there will be a gradual adjustment in US treasuries that will make the longer-dated bonds push higher.
That is not the view of Ece Ugurtas, director of fixed income and currency at Barings, who says: "Brazil is one of the larger indebted countries in the emerging markets universe. It constitutes a large proportion of emerging debt indices and is naturally most vulnerable to any correction in the market.
"To illustrate this point, the Brazil 2040 maturity bond is often used as a barometer of the market. The yield curve is quite steep at the moment, and as such, a low-risk strategy is to be positioned on the shorter end of the curve, at the steepest point of the curve to benefit from yield rolldown. This is currently our favoured strategy in Brazil."
In Turkey, the stable economy and low inflation is proving a good environment for bonds, Papp believes. The main concern for the country is the French referendum on the EU constitution and France's opposition to Turkey joining the EU. For this reason, Papp favours short-dated government bonds in the EU, which will give protection against any potential negative news as the referendum may cause volatility in the market.
Ugurtas says: "For Turkey, external spreads remain tight and we believe there are more interesting opportunities in the local markets. As disinflation, fiscal improvement and the positive macro story continue, further interest rate cuts will drive local bond yields considerably lower. Together with the IMF/ EU anchor, the macro environment means there is much more potential in the local versus external markets. Local bonds are indeed an attractive investment proposition."
Ugurtas believes if the French referendum yields a 'No' it would cause volatility for Turkish bonds and currency markets. He thinks managers would also be inclined to pick attractively priced assets for what is an improving credit convergence story.
In Russia, Papp favours corporate bonds as government bonds have already priced in positive news. He likes companies in the consumer and banking area that are closely aligned with government as they stand to benefit from strong growth in the country. This is because the government is not friendly to companies that are not aligned to their policies, such as Yukos.
Ugurtas says Russia's macro fundamentals are impressive with a sizeable current account, budget surpluses and mounting currency reserves. Concerns over the rule of law and Putin's power over most aspects of the economy remain important, yet secondary, questions for debt holders and ultimately do not affect the ability of the sovereign to service its debt as seen by its strong balance sheet and recent announcements alluding to the eventual buying back of outstanding debt.
Ugurtas says: "There is marginal upside in Russian sovereign debt as spreads remain expensive. An interesting way to play the country's continuing strong macrofundamentals is through quasi-sovereign entities such as oil and gas producer Gazprom, where we can obtain additional yield to the government debt at more or less equivalent risk."
On emerging market bonds, Ugurtas says: "We remain positive on the outlook for the emerging market bonds asset class but cautious on current valuations. As the global macro environment turns with rising US interest rates, mounting concerns in credit markets, spreads remain too tight and do not compensate investors adequately for any potential negative surprises.
"Although individual country fundamentals remain strong and the asset class represents an opportunity to invest in an improving credit convergence story, valuations at this point in the cycle reflect this."
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