Emerging market debt started the year on a strong note. However, from the second quarter onwards, the bout of USD strength led to investors focusing on a number of country-specific issues.
In addition, higher US yields and idiosyncratic factors in Argentina and Turkey (credibility of the Central Bank Policy), Brazil (truckers going on strike and election uncertainty), South Africa (land reforms and concerns over property rights) have been the root cause for weak emerging market debt performance since the beginning of the year.
Selectivity and a robust process
DPAM’s cautious approach, given stretched valuations in some countries (especially in Sub-Sahara Africa and Latin-America) and the portfolio shifting from high to low beta markets at the beginning of the year, have resulted in sound performance relative to peers. Our YTD performance of around -4.75% (institutional F class) compares favorably to peer funds.
The Barclays Local Currency EMD 10% capped index has declined around 6% YTD in EUR terms while the JP Morgan GBI EM has shed more than 8% over the same period. Our sustainability approach selecting countries with sound democratic values and excluding non-democratic regimes (e.g. refraining from investing in from Russia) and our broad diversification again proved instrumental in reducing volatility on an absolute level.
Optimal risk-return
The strategy continues to exhibit an optimisation of the risk-reward proposition.
The sustainability analysis of countries makes it possible to clearly identify investment risks and opportunities based on a holistic and fundamental approach that is independent of market indices. During volatile times, the filter’s contribution becomes more important due to its relatively defensive profile.
Outlook
The outlook for global growth remains robust, global liquidity is still abundant (the cumulative Central Bank Balance Sheet is still above December 2017 levels) and global PMI (53.3 in August) are good. Also, the FED’s future rate path (fewer hikes) could provide some relief for emerging markets going forward.
Despite contagion risks to the broader emerging market universe, the risk of additional US trade tariffs on China and potential portfolio outflows in the asset class, we believe that valuations in countries with external balances under control are getting attractive. This is, amongst others, the case in Indonesia, Mexico, Colombia, India and Brazil. In these markets we are adding exposure on further weakness. Emerging market debt is an asset class worth sticking to in the long run. The countries in the portfolio have sound fundamentals and the asset class provides good diversification in a traditional (fixed income) portfolio.
