Sovereign emerging bonds: being selective is essential
The market is becoming more accessible, providing fresh opportunities to investors who only hold developed country sovereign debt. “After a choppy 2018, the potential for emerging country sovereign debt to create value is still intact this year, as long as investors are highly selective and flexible”, says Jean-Jacques Durand, Head of Emerging Debt Total Return who runs Edmond de Rothschild Fund Emerging Bonds at Edmond de Rothschild Asset Management. “Strict discipline over valuations along with a contrarian, opportunist approach will pay dividends over the long term.”
Venezuela is still one of his strong conviction picks in spite of political upheavals in the country. “We reckon that long-term recovery value is much higher than current bond prices.” The country is in the midst of transition and has the largest oil reserves in the world. Oil accounts for 95% of its exports. To preserve investments destined to reboot its oil industry, the next government will have to sit down at the negotiating table. For Jean-Jacques Durand, “the opposition is well aware of the challenges ahead. Juan Guaido has recognised all the country’s outstanding debt and means to work with international creditors over restructuring plans.”
The fund manager also thinks Turkey provides an investment opportunity, especially because of attractive valuations. The country has low debt levels and has managed to keep its deficit under control. “True, the political situation is still complicated but President Erdogan can be pragmatic when he has no choice. Unlike Russia, Turkey cannot afford to be economically isolated.” Argentina, which is also undergoing transition, is another large portfolio position, along with Ukraine.
The investment team invests primarily in hard-currency sovereign or quasi-sovereign debt because the segment offers a very wide variety of investment vehicles. The fund managers point out that hard-currency emerging country debt has not seen two consecutive years of negative returns since 1991.
The team is well aware of market risks from rather high valuations -even if they are still attractive for countries like Turkey, Argentina and Venezuela- and so has built up cash and taken out hedges to seize any fresh opportunities.
Building on its emerging country debt expertise, Edmond de Rothschild Asset Management has launched a new fund, EdR Fund Emerging Sovereign. Its investment philosophy is similar to EdR Fund Emerging Bonds, as it avoids benchmarked investing to make strong bets. The strategy is, nevertheless, less aggressive and seeks to limit risk-taking by excluding CCC-rated bonds in the high yield segment so as to cushion any shocks. Combined with a precise risk-control process, this approach gives the fund a risk/return profile half-way between emerging debt market indices and EdR Fund Emerging Bonds.
Emerging market corporate debt: A must-have segment
Thanks to its attractive valuations, corporate emerging country debt is now a must-have segment in the rich and diversified fixed income universe. With today’s upbeat macroeconomic environment, companies have comfortable amounts of cash so default rates are low. Corporate emerging debt gives investors access to a broad variety of sectors, companies, geographical zones and credit ratings. It also means being able to invest in companies which are not listed on equity markets and which prefer to sell debt before considering an IPO. The segment’s risk/return profile is particularly attractive and total returns, bolstered by generous coupons, mostly set it apart from performance in other bond classes.
Stéphane Mayor, Head of Emerging Corporate Debt who runs Edmond de Rothschild Fund Emerging Credit at Edmond de Rothschild Asset Management, allocates a high percentage of the fund to hard-currency high yield bonds with spreads of around 500bp which are likely to produce attractive returns. Brazil is the fund’s biggest position. For the fund manager, “the country is still on an appealing growth trajectory and the essential pension reform which has been engaged should bear its first fruits this year.”
Thanks to ongoing normalisation after the agreement on debt restructuring, Ukraine is another high-conviction position. The country currently boasts one of the best risk/return profiles in the investment universe. Argentina and Turkey have seen choppy trading in recent weeks but they could also come back into favour with investors and offer interesting returns. Russia and Nigeria are also well-represented in the fund. “We are focused on commodities like oil and gas as well as metals and mines,” says Stéphane Mayor, adding that he also likes financials and consumption plays.
His investment approach is based on strong, non-benchmarked convictions. Starting with a top-down scenario (countries, commodities, political environments and sectors, etc.) as well as bottom-up analysis, he picks companies with the most attractive risk/return profiles. He only invests in companies which he knows well and has regular meetings with management teams. For him, “geographical and sector diversification is a key part of portfolio construction when looking to limit risk.”