What s Next for Emerging Markets Debt?

Transcription

1 1998 What s Next for Emerging Markets Debt? EMERGING MARKETS DEBT TEAM AUGUST has been challenging for Emerging Markets Debt (EMD). After a solid 2012 in which the EMBI Global Diversified Index provided an 18% return, investors reacted to slowing economic growth and concerns about U.S. monetary policy by reducing exposure to the asset class, which declined by 8.5% in the first half of the year. What does near-term volatility imply for the rest of the year and beyond? Is it an opportunity, a warning sign, or something in between? In the near term, our perspective is cautious. The asset class has hit an inflection point of market adjustments to the potential beginning of the end of ultra-easy global monetary conditions. Higher rates imply a rotation away from more volatile fixed income areas and into more traditional market segments. However, despite recent noise to the contrary, emerging market (EM) economies are generally expected to improve (see Figure 1) and remain stronger than developed market (DM) counterparts; the financing needs of sovereign and corporate issuers are relatively moderate potentially limiting supply and supporting credit fundamentals and spreads. FIGURE 1: STRONG REAL GDP GROWTH IN EMERGING MARKETS Advanced Economies Emerging Markets Differential F Growth (%) F Source: International Monetary Fund, as of July Just as important are the discounts in emerging markets versus developed market counterparts, reflecting less the realities of credit and interest rate concerns than overall market inefficiencies and a yield premium associated with perceived risk. 1

2 In general, we believe that investors have made too much of slowing growth in emerging markets. In general, we believe that investors have made too much of slowing growth in emerging markets, and we expect some economic resurgence, supported by global recovery, particularly in the developed markets, which should partially offset China s slowdown, even as EM policymakers gradually scale back monetary support. In terms of individual segments: We believe that Sovereign credit spreads are attractive relative to historical levels and current expected default rates. Low/medium spread names have moved to what we consider compelling levels, although higher yield and frontier issues seem more risky from a valuation perspective. Corporates, meanwhile, should largely mirror Sovereign performance, but carry some risk due to recent outperformance versus Sovereigns. Among Corporates, high yield issues offer an additional spread cushion in the event of a U.S. Treasury sell-off. Local Currency debt is our preferred market segment through year-end. EMD should continue to benefit from the long-term trend of inflows, as investors within fixed income add exposure to emerging markets. Local Currency debt is our preferred market segment through year-end. EM central banks are mostly neutral to accommodative, which should limit risk from U.S. interest rates. While below-potential growth is likely to be beneficial for EM local bonds, monetary shifts between EM and the U.S. and commodity weakness may hamper the currencies in which such debt has been issued. These views reflect our base forecast. If economic growth proves stronger than we anticipate, EMD spreads are likely to narrow on improving credit fundamentals, but to some degree this should be offset by higher Treasury yields, particularly for Sovereigns. A slower growth scenario would likely provide stronger total returns for all three segments (especially Sovereigns) given implications for U.S. Treasuries, while a renewed global slowdown (our least likely scenario) would be negative across the board. Overall, EMD s recent underperformance relative to U.S. spread products and European peripheral sovereigns have improved the relative value of EMD. While the next several months may see tactical outflows due to U.S. rate increases, we anticipate that flows will be positive, at roughly $40 50 billion for the full year. Moreover, EMD should continue to benefit from the long-term trend of inflows, as investors within fixed income add exposure to emerging markets, which are structurally underrepresented in their portfolios. Mercer reports that only 13% of European pension plans have allocations to EMD, compared to 35% with allocations in Emerging Markets Equity. 1 U.S. pension exposure to EMD is generally considered to be even smaller, with minimal allocations in most portfolios. 1 Source: Mercer Asset Allocation Survey: European Institutional Marketplace Overview 2013, Marsh and McLennan Companies. 2

3 FIGURE 2: WE BELIEVE RECENT NEGATIVE FLOWS ARE TEMPORARY Net Flows to Emerging Markets Debt 100 US$ bn Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Sources: J.P. Morgan and EPFR Global. The EMD team uses broker assessments from HSBC, J.P. Morgan and Bank of America Merrill Lynch to approximate the range for annual flow estimates. Actual flows may vary. ECONOMIC BACKDROP With the scenario of improving U.S. growth dominating investor perceptions, the Federal Reserve policy will likely prove highly influential to EM results. Moderate Second-Half Gains Although emerging markets have shown economic resilience since the financial crisis, overall results have been affected by European weakness and the subpar expansion in the U.S., while there has been periodic anxiety about China s efforts to avoid property speculation and develop a more balanced economy. The crisis has also introduced new challenges for policymakers, in that the new normal in the DM, translating into lower consumption, has made the export-orientated EM growth model less viable. This is pushing emerging markets to rebalance their economies in favor of domestic consumption and away from heavy investment, resulting in tougher times for commodity exporters. In our view, ongoing normalization of economic conditions in developed markets will remain a key driver for EMD in the remainder of With the scenario of improving U.S. growth dominating investor perceptions, the Federal Reserve (Fed) policy will likely prove highly influential to EM results, as was demonstrated in the setbacks after the Fed s references to tapering its QE-related asset purchases. Our base case is that the Fed will reduce such purchases later in 2013; as such, U.S. Treasury yields should trend somewhat higher and could become more volatile as investors begin to price in more recovery and lessen their fixed income purchases. 3

4 FIGURE 3: REAL GDP GROWTH (%) IN KEY EMERGING MARKETS Country F 2014F Brazil China India Korea Mexico Russia Turkey Source: Neuberger Berman. F = forecast. While recent weakness has dampened our expectations generally, we believe EM growth is likely to accelerate modestly from 4.8% for the first half, to reach 5.3% for the full year. We expect the unwinding of last year s stresses in the eurozone, as well as the lowering of interest rates by several central banks, to support growth in EM Europe. While recent weakness has dampened our expectations generally, we believe EM growth is likely to accelerate modestly from 4.8% for the first half, to reach 5.3% for the full year, roughly on par with 5.2% in 2012 and reach 6.1% in This would be aided by the global recovery, stronger second-half growth in China and continued support from EM policymakers. Looking at economies by geography, China is obviously a key factor in EM economic health. Recent softening has contributed to weaker commodity prices, which has impacted producing countries broadly. Even with current challenges, however, we believe that the country could grow by 7.6% this year, with the new government settling in, social financing growth filtering into investments and increased real estate investment on rising property sales. Past expectations of 9 10% annual growth are no longer realistic, but the new, cooler rate is supportive for Asian and other EMD markets. Overall, growth in EM Asia should pick up by 10 basis points to 6.5% this year and further to 6.7% in 2014, with the more advanced Asian economies of Korea, Taiwan, Hong Kong and Singapore moving to catch up to the ASEAN-4 (Indonesia, Malaysia, Philippines and Thailand), thanks to a continued recovery in exports to the U.S. We have increased our GDP growth forecasts in India by 60 basis points to 6.3% for 2013 and expect 7.2% for 2014, looking past current tightening in India, which we deem as temporary. Inflation remains tame but the combination of very accommodative monetary policy and strong domestic demand growth in the ASEAN-4 may drive inflation higher. In another sign of the influence of DM economies, we believe Japan s monetary shift is a positive for EM Asia. Japan s recently introduced program to reflate the economy will likely impact the region in two ways: First, the country is now more competitive with EM Asian markets, of which Korea appears most vulnerable due to a high degree of similarity. That said, some Southeast Asian exporters provide goods that are complementary to Japanese exports and would likely benefit. Thailand comes to mind, as it imports a large chunk of its intermediate goods from Japan. Second, a rise in Japan s domestic demand could increase imports from other Asian countries. Indonesia and Malaysia are the best placed in the region to capitalize, as they export a large portion of their commodities to Japan. The expansion in EM Europe should remain on track at 2.2% in 2013 and rise to 3.1% next year. We expect the unwinding of last year s stresses in the eurozone, as well as the lowering of interest rates by several central banks, to support growth. 2 The macroeconomic forecasts by the EMD team rely on in-house research and a wide range of external research sources on 75 countries in the EMD universe. Global and regional aggregates are GDP-weighted if not specified otherwise. Forecasts may not materialize. 4

5 Growth in the Middle East should soften due to flattening crude oil production by the Gulf Cooperation Council member states. Growth in Africa should remain flat at 4.1% this year as post-arab spring challenges and weak commodity prices hold back many economies, but should then accelerate to 4.9%. As for Latin America, we believe the slight uptick in expansion there should be driven by the recovery in Brazil (from 0.9% last year to an expected 2% in 2013), while Mexico is likely to slow from 3.9% to 2.8%. Fiscal challenges are increasing rapidly in Venezuela and Argentina, as the authorities have elevated public spending ahead of elections in April and October of this year, respectively. HARD CURRENCY SOVEREIGNS Long-term prospects remain favorable as the levels of growth, albeit slightly lower, and overall healthy fundamentals should combine to maintain the long-term decline of government debt to GDP. Stronger Than Consensus Expectations We disagree with recent market consensus, which we believe has focused too much on the downscaling of growth expectations. In our view, long-term prospects remain favorable as the levels of growth, albeit slightly lower, and overall healthy fundamentals should combine to maintain the long-term decline of government debt-to-gdp, which is a reliable indicator of sovereign credit quality and supportive of prices. Still, current U.S. interest rate dynamics present a headwind for near-term performance. Looking at EM public debt, the market is likely to grow from its current $7.8 trillion to roughly $8.3 trillion (81% in sovereign debt) this year, or more than three times its level in At the same time, public debt in EMBI countries should decline as a percentage of GDP from 43.6% in 2012 to 41.7% next year, a sign of continued progress in government finances. Indeed, EM fiscal balances are likely to average a modest -2.8% of GDP in FIGURE 4: EM GOVERNMENT DEBT LOADS CONTINUE TO MODERATE Argentina Brazil China Colombia Hungary India Indonesia Lebanon Malaysia Mexico Nigeria Pakistan Public Debt as % of GDP Peru Philippines Poland Russia South Africa South Korea Thailand Turkey Ukraine Uruguay Venezuela F Sources: Historical data: International Monetary Fund, 2014F: Neuberger Berman internal forecast. Despite long-term price gains, Emerging Market Sovereigns offer a roughly 320 basis-point advantage over 10-year U.S. Treasuries 4 compared to a low of 155 basis points before the financial crisis in 2007; at the time, the average credit quality was lower than currently, which reinforces our constructive long-term view. 3 Source: J.P. Morgan. 4 As of July 23,

6 We are cautious on EM Sovereigns as the low-rate environment that has led to significant inflows into the asset class could diminish or fade with the U.S. recovery and higher rates. However, for the near term, we are cautious on EM Sovereigns as the low-rate environment that has led to significant inflows into the asset class could diminish or fade with the U.S. recovery and higher rates (see Figure 5). U.S. Treasury yields have been climbing since the beginning of the year, resulting in EM Sovereigns suffering, in the first quarter, their worst quarterly performance since late 2008, following an impressive 18.5% gain in While the Bank of Japan s aggressive quantitative easing program slowed this downturn in March, we believe that expected volatility in Treasuries will require a prudent stance in the coming months, at least from a total-return perspective; we are less concerned with spreads given reasonable valuations, supportive fundamentals and a positive supply/demand picture for EMD. FIGURE 5: U.S. RATE DECLINES BOLSTERED EM FLOWS Cumulative Flow in US$ billion Hard Currency Local Currency 10-Year U.S. TIPS 0 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec Sources: Bloomberg and EFPR Global, J.P. Morgan. Data through July 29, While the market focus has been on the high yield segment of the universe, we think that the spread widening seen in the first half of the year resulted in opportunities for investment grade credits. Repricing Offers Opportunity Within the Sovereigns market, we believe a focus on relative value and bottom-up fundamentals will be key when it comes to individual countries, regions and credit-rating segments. While the market focus has been on the high yield segment of the universe, we think that the spread widening seen in the first half of the year resulted in opportunities for investment grade credits. In Latin America, thanks to a stronger U.S., and ambitious and front-loaded structural reforms, we believe Mexico is on a favorable trajectory, followed by Brazil, where growth is set to accelerate this year from a sluggish 2012, despite recent political noise caused by a widespread protest movement. We also believe several medium-beta countries in EM Europe, namely Hungary, Kazakhstan and Romania, should do well. The graduation of Hungary and Romania from the European Union s Excessive Deficit Procedure and the start-up of the Kashagan oil field in Kazakhstan should broaden investor interest and improve the risk profile of these countries. Continued unrest-related volatility, as well as ongoing civil war in Syria, makes us very cautious on Egypt (which has now moved to high yield status), Jordan and Lebanon, while our outlook for Iraq and Morocco remains positive. The combination of investment grade and medium-beta countries makes up around 75% of the EMBI GD universe. At current spread levels, we disagree with any market optimism about the high yield part of the market, dominated by Argentina, Venezuela and Ukraine. We see valuations as relatively tight in light of credit quality and economic and political dynamics, which have 6

7 Frontier markets have grown substantially over the past year due to new issuance, but we believe this area is expensive. become more challenging in the past six months. This is particularly true in Venezuela, which faces a stalled economy, currency pressures and continued political tensions. Ukraine has seen a widening current account and growing deficit gap broaden at a time of deep recession. As the highest yielder in the region, it has tactical interest, but increasingly appears a poor medium-term investment. Finally, frontier markets have grown substantially over the past year due to new issuance, and now make up around 10% of the index. In our view, this area is expensive. Economic developments have been tepid at best, and the bonds are trading at narrow spreads due to scarcity value in the face of a wave of demand in recent years. All in all, while we are currently cautious and see further downside risks, we do see value opportunities appearing in our market and have a positive longer-term outlook. CORPORATE BONDS We remain constructive on higher yielding EM Corporates for the second half of 2013, despite potential headwinds from U.S. Treasuries. Focus on Credit Fundamentals While EM Corporates strong 2012 return was largely driven by a strong technical backdrop and U.S. Treasury performance, we believe that individual credit fundamentals have regained importance in the asset class. Valuations are favorable versus U.S. assets, although recent outperformance versus Sovereigns is contributing to risk for now. Default rates for EM high yield bonds, while still a very low 2.7% in 2012, have risen moderately over the past couple of years, leading investors to take a more cautious stance on credits with deteriorating financial situations. Over the past year, leverage has ticked up, while revenue and EBITDA growth have been flat to negative in some cases. With more headline risk for certain credits, we expect defaults to increase for the remainder of 2013, to 3.8%, or slightly above the historical average for EM high yield corporates. 5 We remain constructive on higher yielding EM Corporates for the second half of 2013, despite potential headwinds from U.S. Treasuries; the sector should generally receive support from the improving economic picture, which would provide earnings growth and reduce leverage risks. Also, companies continue to exhibit reasonably strong balance sheets as liquidity has improved, cash balances are firm, and debt maturities have been pushed out as a result of relatively easy access to debt markets. We expect the impact of higher U.S. Treasury rates on EM Corporates to be more moderate than for Sovereigns. This is particularly true in the high yield segment, which offers an additional spread cushion relative to investment grade securities, as well as generally shorter durations. From a valuation perspective, however, while the relative spread pick-up offered by EM Corporates versus U.S. credit (+100 basis points) remains ample, the spread differential to emerging market sovereign bonds has narrowed this year (as corporates have outperformed sovereigns) to about 20 basis points. Although EM Corporates are less interest-rate sensitive given their overall lower duration profile, and issuance has moderated across regions and credit buckets, we believe recent price developments have made them more vulnerable to a technical correction in the short term. However, new issue concessions in corporate debt offerings have returned for the first time in over a year and may offer interesting entry points on a name-specific basis. Figure 6 shows the relative value of EM high yield versus U.S. counterparts in the BB segment. 5 Source: J.P. Morgan. 7

8 FIGURE 6: EMERGING MARKETS HIGH-YIELD CORPORATES REMAIN ATTRACTIVE 1,200 1, EM High Yield U.S. High Yield (BB) EM/U.S. Spread Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Source: J.P. Morgan. EM high yield: CEMBI Broad High Yield Index; U.S. high yield: J.P. Morgan Double B HY Summary Spread to Worst. In the medium term, we believe that continued growth of the EM Corporate asset class in dedicated allocations is likely to improve liquidity and make the asset class increasingly appealing to mainstream investors. In the medium term, we believe that continued growth of the EM Corporate asset class in dedicated allocations is likely to improve liquidity and make the asset class increasingly appealing to mainstream investors. Overall, we believe that credit differentiation will be an important driver for alpha this year in an environment of more modest index returns. OUTLOOK BY SECTOR Fundamentals for Financials, which account for approximately 30% of the EM Corporate universe, have remained moderately strong, and in some cases have improved. This has been most notable in Brazilian banks, which were hampered by a weaker macro environment. Despite the slowing economy and potential stress on the local financial system, the country s banks are getting a better handle on non-performing loans as part of their gradual recovery. We are also positive on high-growth countries such as Peru and Colombia, which provide a combination of good credit metrics, attractive domestic growth and strong regulatory environments. However, we are cautious on Turkish banks and corporates due to the recent political uncertainty, as well as on Chinese banks. In Energy, we are more positive long term on oil producers than gas producers given the strong supply/demand dynamics. The EM Energy sector is dominated by blue chip, investment grade issues. While many are fundamentally strong, there has been some deterioration in a number of large Latin American oil and gas names. Also, the propensity for significant capital expenditures and major acquisitions creates risk of earnings pressure and/or increased leverage. We see more opportunities in BB and B-rated high yield securities with companies that demonstrate reasonable fundamentals and a strong track record. We are cautious on Metals and Mining due to rising leverage, pressure on margins, weak demand growth, increased supply and generally lower commodity prices. The steel sector has been hit particularly hard due to softer Chinese demand. Our view is mitigated somewhat by the expectation that exporters could benefit from a stronger dollar and improved outlook for Chinese growth in the second half. However, we expect to see further downgrades in the coming months. 8

9 We are also cautious on the Telecom sector as fierce competition in many regions has pressured revenues and EBITDA margins. Capital expenditures have soared as companies race to increase market share and expand product offerings. Barring individual exceptions, we believe that the spreads for many of telecom credits do not provide adequate compensation for their weakening credit profile. LOCAL CURRENCY BONDS We maintain a positive outlook for local currency bonds, due to reasonably attractive valuations and high carry and risk premiums compared to G3 currencies. Attractive Valuations, Growth Potential We have a tentative near-term view of Local Currency bonds given risk of more weakness in EM interest rates in reaction to higher U.S. rates, despite the longer term positive implication for emerging markets of favorable U.S. growth. Still, we expect the impact to be contained as the combination of recently lower than-expected growth and inflation in the emerging world give central banks more room to cut rates. Also, attractive yield differentials relative to developed markets continue to provide a cushion as to upward pressure from U.S. rates. Intermediate term, we maintain a positive outlook for local currency bonds, due to what we consider reasonably attractive valuations and high carry and risk premiums compared to G3 currencies. Capital flows remain positive, with stable foreign direct investment at 1 2% of GDP, on average, in combination with robust portfolio flows. Despite the global rate rally in both developed and emerging markets, we favor extended duration in local EM issues, based on superior fiscal performance relative to developed markets, foreign flows into local bond markets and reasonably attractive valuations, illustrated by high real rates (see Figure 7). FIGURE 7: LOCAL CURRENCY YIELD ADVANTAGE Five-Year EM versus G3 Real Rates Japan Germany UK US Indonesia* 1.42 Malaysia* 1.77 Thailand*** 1.30 South Africa 0.02 Russia* Turkey 3.77 Hungary* 3.03 Poland** Peru Colombia 3.03 Chile 2.30 Mexico 1.62 Brazil * Backed out from nominal bonds and current CPI. ** 3-year bonds for Poland. *** 7-year bonds for Thailand. Sources: Bloomberg and Neuberger Berman, as of July 19, Looking at currency dynamics, the U.S. is leading the global economic cycle, increasing the odds of a stronger dollar, at least initially, which could weigh on EM denominations. More important, investors are anticipating a shift in the Fed s monetary policy, reflected in the changing correlation between EM FX and global risk sentiment (with the S&P 500 Index as proxy) and the euro (see Figure 8). 9

10 FIGURE 8: SHIFTING PERCEPTION OF EM CURRENCIES Correlation of EMFX Returns vs. SPX and EUR % May-05 Oct-06 Feb-08 Jul-09 Nov-10 Apr-12 Jul-13 Correlation of EMFX with SPX Correlation of EMFX with EUR Sources: Bloomberg and Neuberger Berman, as of July 19, Although EM FX appreciation has generally coincided with periods of strong U.S. equity performance, the relationship often breaks down during Fed action or when the market speculates about changing Fed policy. In the current instance, markets have been repriced to reflect much of the expected monetary change. Once the process is completed, we would expect, on the margin, better EM foreign exchange performance. Finally, although EM current accounts remain in positive territory, some deterioration has occurred as sluggish global growth has slowed exports in contrast to relatively resilient domestic demand. OUTLOOK BY REGION In Latin America, most central banks remain dovish or neutral given subdued inflation with the exception of Brazil. Easing Trend in Latin America In Latin America, most central banks remain dovish or neutral given subdued inflation, with the exception of Brazil. Periods of U.S. dollar strength tend to be negative for commodity prices; given that commodities are a key part of Latin America s export base, we see the potential for further headwinds to growth, fiscal targets and current accounts. Brazil has started to increase rates, as inflation remains high. However, the temporary inflation shock from higher food prices should fade in the latter part of 2013, suggesting that an emphasis on longer durations could prove beneficial. Near term, we remain cautious in the region in terms of FX, due to deteriorating terms of trade and potential monetary easing. EMEA: Diversified Economies Favored In EMEA, we see tentative signs of growth, though with a clear divergence between economies that are weaker due to their orientation to the eurozone (Czech Republic, Hungary and Poland) and those with a more diversified export base (Turkey, Israel, South Africa and Nigeria). With reduced tail risks from the euro area, we foresee policy decisions that will focus on (a) the new normal of potentially lower economic growth and (b) less reliance on exports especially to Europe as a source of expansion. 10

11 We favor currencies with a strong external position over those with a weak external position and high reliance on portfolio flows. In Asia, we are quite sanguine on regional currencies as a whole, though of mixed views with respect to duration over the longer term. With rates in the region at near all-time lows, the diminishing carry component is being offset by strong inflows into fixed income markets. Given the significance of portfolio inflows over foreign direct investment as a source of capital, we feel that the outlook for EMEA currencies will very much be a function of the extent of core market monetary policy normalization going into the second half of In this environment, we favor currencies with a strong external position (Israel, Czech Republic, Hungary, Nigeria and Russia) over those with a weak external position and high reliance on portfolio flows (Turkey, South Africa and Poland). Despite the tentative recovery in growth and low rates, we believe the potential for easing by EM central banks remains intact. However, the potential fiscal expansion remains limited, at best, as many economies are still in the balance sheet repair phase, post crisis. Hence, we believe that stimulus will come from monetary policy and/or targeted lending schemes (for example, in Hungary). We believe Romania and Russia will continue easing monetary conditions in the coming months as the lag in transmission from lower commodity prices and/or base effects brings down headline inflation. As with FX, we anticipate risks to local yields coming primarily from the normalization of core market yields, which could put pressure on markets where real yields remain low or negative and foreign ownership remains high (South Africa, Poland and Turkey). We are optimistic on duration in countries where markets have not priced in sufficient easing and where real rates are high and positive (Romania, Russia, Israel and Hungary). Asia: Duration is a Question In Asia, we are quite sanguine on regional currencies as a whole, though of mixed views with respect to duration over the longer term. Most Asian economies still retain a high degree of correlation to the U.S. economy; given encouraging signs in the U.S., we anticipate improvements in Asian economic growth and current account surpluses in the coming months. After a disappointing first half, we anticipate reasonably robust Chinese expansion for the rest of 2013, bringing the annual growth rate to 7.6% (in the higher range of market expectations), which will likely be accompanied by a series of reform measures. At the same time, we believe that a structural moderation in Chinese trend growth is inevitable. Consequently, while we do not expect any significant appreciation of the renminbi in the immediate future, we do expect other Asian currencies to benefit from dissipation of China hard landing fears. Further, we believe that regional central banks (apart from India and Thailand) are unlikely to continue with the current level of monetary accommodation, which should benefit their respective currencies. Within the region, we expect the currencies of consumer goods exporting economies to outperform those of commodity exporters, which are facing pressures due to persistent deterioration in terms of trade. We also note that some of the key regional economies are facing political headwinds in the form of important state/party elections over the next few months. Going forward, we expect some of the current political risk premiums to be reduced as the political uncertainties dissipate. On duration, the lower yielding markets are unlikely to witness further monetary accommodation; and should global growth continue to improve, the bond yields in these markets will likely trend higher. On the other hand, we believe that markets such as India and Thailand face some near-term growth concerns. Given recent weakness, coupled with potential monetary stimulus going forward, they have the potential to deliver strong 11

12 performance over the next year. The strength in Asian sovereign balance sheets continues to attract offshore flows to local bonds, given the very attractive risk-adjusted spreads they offer over developed market bonds. We believe such flows will remain a strong technical support to these markets for the foreseeable future. We believe the structural case for EMD remains strong, as investors increasingly recognize the economic significance, improved credit quality and depth of EM economies and markets. CONCLUSION The global fixed income universe, including the emerging markets, continues to see near-historic low yields, reinforcing the appeal of taking an opportunistic, global approach to bond investing to broaden potential sources of yield and total return. Within this context, we believe the structural case for EMD remains strong, as investors increasingly recognize the economic significance, improved credit quality and depth of EM economies and markets and, accordingly, make up for prevailing low allocations to EMD. Although improved global growth could provide a near-term headwind of higher Treasury rates, we believe that slow, steady economic improvement could provide a modestly positive backdrop for EMD, particularly in comparison to other sectors within fixed income. CONTRIBUTING EMERGING MARKETS DEBT TEAM MEMBERS ROB DRIJKONINGEN GORKY URQUIETA BART VAN DER MADE RAOUL LUTTIK NISH POPAT JENNIFER GORGOLL PRASHANT SINGH KAAN NAZLI SUKHJEET REEHAL RAM BALA CHANDRAN MICHAEL REYES PUAY YEONG GOH VERA KARTSEVA Neuberger Berman LLC 605 Third Avenue New York, NY DISCLAIMER This document is intended only for the person to whom it has been delivered. 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