Lessons from Turkey and Argentina: Where is the value in EMD now?

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 Alejandro Arevalo, Jupiter
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Alejandro Arevalo, Jupiter

Industry Voice: Alejandro Arevalo, Manager of the Jupiter Global Emerging Markets Corporate Bond and Jupiter Global Emerging Markets Short Duration Bond Funds, discusses lessons learnt from recent crises in Turkey and Argentina this year, and how this has created new opportunities in EMD

Sentiment towards emerging markets was particularly strong in 2016 and 2017, fuelled by a combination of synchronised global growth and strong local demand. With central banks across the globe cutting interest rates, and inflation expectations at all-time lows, emerging market fundamentals looked strong.

However, at the beginning of this year a number of external risk factors became apparent. The Federal Reserve was fixated on raising rates, while growing protectionism in the US increased the threat of a global trade war. The stronger dollar also impacted emerging markets, hitting those countries with the biggest current account deficits the hardest.

The first of these was Argentina: a one-time darling of emerging markets. As many investors know, markets lack patience and it seems President Mauricio Macri's reforms had not come at the speed many had been anticipating. Concern surrounding the country's repayment capacity began to grow, and as a result the currency has lost around 50% year-to-date. Meanwhile, USD denominated Argentinian bonds have lost 20%-40% of their value1.  

Argentina's troubles started something of a domino effect. Investors started to focus on the weakest links in emerging markets and the next country to experience difficulties was Turkey.  In Turkey, investors were spooked by President Recep Tayyip Erdoğan's stewardship of the country which could potentially jeopardise the credibility of an already weak central bank. The impact on the Turkish lira and bond market this year was very similar to what was seen in Argentina.

Investor sentiment

What happened in these two countries is arguably shaping investor sentiment towards the emerging market region as a whole in 2018.

Yet when I look at my own investible universe, it encompasses close to 60 countries many of which have a stronger focus on reform than ever before. For example, rate hikes have already been seen across Indonesia and India this year, whilst expectations of further increases in Russia are likely to play out. Meanwhile, a number of central banks across emerging markets are taking a more proactive stance as they look to protect their economies from negative investor sentiment - even though inflation expectations remain well anchored there

Perhaps most importantly, events this year have made emerging market bonds as an asset class more attractive than at any point over the past two years. I believe this is for several reasons.

Firstly, volatility has created attractive entry points to improve the overall quality of the portfolio without giving up much in terms of yield. In many instances, bonds are significantly mispriced due to the indiscriminate sell off from non-dedicated EM investors, and aggregate spreads between emerging market debt denominated in dollars and US Treasuries are at the widest we have seen since the beginning of 2016. Spreads year to date have widened from the tights of 250 bps at the beginning of the year to 340 bps at the start of September 20181.

Secondly, I am seeing more opportunities in the long part of the yield curve. This is because investors concerned by the Federal Reserve's tightening cycle often follow a consensus trade to buy bonds with very short-term maturities resulting in steeper curves. In my view, investors are being compensated to extend duration.

Given our cautious outlook in the short term, due to the external factors mentioned above, we are favouring low beta countries such as Kuwait and UAE in the Middle east, which have very strong macro indicators. I also like some Asian countries, such as Singapore, Korea and Hong Kong, which are supported by a combination of very strong quality names and investor demand.

Avoiding local currency in the short term

However, lessons have also been learnt from the change in sentiment towards emerging markets this year. Events in Turkey and Argentina specifically have shown that local currency tends to take a direct hit when investor sentiment changes. Both the Turkish lira and the Argentine peso have lost some 50%-60% of their value this year1. In the short term, we believe the USD will continue its upward path and most  imbalances at the macro level across several emerging markets will be adjusted through the local currency movements.

I am comfortable with this strategy in the short term as we have also increased our allocation to corporates. Our thesis that emerging market corporates outperform in a volatile market has proven correct throughout this year. And with more investment grade names on offer in the corporate index, this is where I anticipate I will find most of my opportunities. Although markets are likely to see slightly lower issuance this year, over the long term I expect to see a very similar trend in terms of supply, with good quality companies continuing to diversify their funding bases. 

 

Important information

This article is for informational purposes only and is not investment advice. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested.

The views expressed are those of the Fund Manager at the time of writing, are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given.

Jupiter Unit Trust Managers Limited (JUTM) and Jupiter Asset Management Limited (JAM), registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ are authorised and regulated by the Financial Conduct Authority.

 

1 Source Bloomberg

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