Emerging markets: Issuance frenzy and complacency about growing risks

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1 By Naman Agarwal November 3, 2017 Low interest rates have propelled a search for yield and rotation into higher-yielding emerging market (EM) debt, resulting in record inflows into the asset class. As discussed by Fernanda Fenton in April, the investor base continues to grow beyond dedicated EM investors, further intensifying the rally in EM sovereigns. In the current year, this rally has been led by a mix of debt-laden and less financially mature markets like Ukraine, Argentina and Ecuador. This high-risk appetite despite lower risk premiums is shown in the tightening spreads in Chart 1 across the credit spectrum. The spread here represents the additional income of credit products over the similar maturity US treasuries. Chart 1: Risk premia falling across various spread products Source: Bloomberg, Global Asset Management EM countries have kept pace in meeting this ever-growing demand and are on track to issue more than $165 billion of sovereign debt denominated in developed market currencies, almost twice the amount raised in 2015 as shown in Chart 2. Uneasy takeaway from the International Monetary Fund (IMF) confirmed this complacency Our primary takeaway from recently concluded IMF meetings was that most EM investors believe exposure to less liquid sovereigns and participation in new issuance are the only game in town to add alpha or outperform indices. This was reflected in the most curious of recent issuances: a 10- year USD 500 million bond offering by Tajikistan, a former soviet republic with USD 7 billion GDP. 2 Queen Street East, Twentieth Floor, Toronto, Ontario M5C 3G7 I Head Office / Toronto Calgary Montreal Vancouver Client Services English: French:

2 Even though this single issue represents 7% of the country s GDP and 675% of its FX reserves, Tajikistan had to merely offer a 7.125% yield for the deal to be 8 times oversubscribed. Other examples of issuers obliging insatiable hunger for yield include an USD 1.50 billion 15-year bond issued by Nigeria, a country with debt service-to-revenue ratio of nearly 40%, and a newly launched 5.5-year USD 800 million bond offering by Mongolia that is expected to yield 6.1% a fairly cheap rate for a country that agreed to a USD 5.5 billion IMF bailout earlier this year. Chart 2. Record levels of emerging market hard-currency sovereign issuance Source: JP Morgan, Bloomberg s rationale and EM positioning Outside the realm of this yield grab, in July we anticipated a slowdown in inflation that would benefit both long duration and risky spreads (see Kamyar Hazeveh s Fixed income mid-year review ). EM debt has both these attributes and has returned 8.67% year-to-date with duration contributing 1.96% and spread 6.71%. s EM assets have played an important role in diversifying our funds and improving risk-reward as Kamyar mentioned in his blog post Portable beta in modern fixed income design.

3 Regional Wgt Attributes Emerging markets: Issuance Table 1: EM positioning across strategies Dedicated EM strategy Global Bond Fund Tactical Bond Pool US Aggregate Canadian Bond Fund Short Term Bond Fund Weight (% of market value) 91.7% 14.8% 7.4% 7.3% 2.0% 2.1% Avg. Credit Rating BB+ BB+ BB+ BB+ BBB BBB EM Spread (bps) LATAM 50.4% 50.4% 50.4% 50.4% 61.9% 61.8% ASIA 12.7% 12.7% 12.7% 12.7% 4.4% 4.4% CEEMEA 36.9% 36.9% 36.9% 36.9% 33.7% 33.7% Source: Global Asset Management, Bloomberg We are cautious of the tight spreads, and to manage overall risk-return of our dedicated EM mandate, we currently hold a moderate duration underweight as well as a credit underweight. The back-end exposure in our holdings is dominated by high-quality debt of Mexico, whereas our frontend exposure is in a mix of higher-yielding countries like Argentina, Turkey and Brazil. Our large underweight position in Turkey, a country we have not been constructive on since the beginning of 2017, has hurt the performance compared to our benchmark (JPMorgan Emerging Market Bond Index Plus). The other large underweight position is in the Philippines, one of the most expensive credits among investment grade EM sovereigns. We also hold an overweight position in Brazil, which, coming out of a recession, has a favourable external backdrop and improved fundamentals. Conclusion As the momentum trade continues to look past economic fundamentals and spread compensation for risk continues to decline, a big risk to EM spread seems to be capital outflows from developing countries and portfolio re-allocations by global institutional investors. With this backdrop, we believe that the market may experience increased volatility and see a high value in good fundamental and macro analysis. Therefore, we remain cautious and continue to wait for spread levels that are truly representative of the risks to cover our underweight position.

4 APPENDIX Performance update: Global Bond Fund Global Bond Fund is the largest holder of emerging market bonds among our mandates. As of October 20 th, Global Bond Fund returned 0.45% year-to-date, adding 27bps of alpha compared to the benchmark return of 0.18%. Underweight duration and curve positioning added 45bps of alpha, whereas an average allocation of roughly 11% to EM assets contributed 65bps of alpha to the fund. Currency returns have detracted 112bps from the alpha performance. Please refer to the table below for a detailed breakdown of the performance. Table 2: Global Bond Fund Class F year-to-date performance (gross of fees, taxes and expenses) as of October 27, 2017 Global Bond Fund JPM Global Government Bond Index Difference Local return Components of local return: Curve & Duration 0.43 (0.02) 0.45 Total Excess Governments (0.63) Mortgages & Securitized Inflation-Linked (0.05) - (0.05) Emerging Markets Corporates Preferred Shares Currency return (1.79) (0.67) (1.12) FX overlay Total Source: Global Asset Management, Bloomberg. Class F returns net of fees are disclosed below.

5 Strategy Attributes Emerging markets: Issuance Chart 3: Global Bond Fund emerging market weight relative to the benchmark Source: Global Asset Management, Bloomberg Table 3: duration-sensitive fixed income product suite Canadian Fixed Income Global Fixed Income Flexible Fixed Income Exchange Traded Funds Name Benchmark Description Foreign Currencies Benchmark Duration Short- Term Bond Fund FTSE/TMX Canada Short-Term Bond Total Index Low Duration Fixed Income Canadian Bond Fund FTSE/TMX Canada Universe + Maple Bond Index Traditional Canadian Fixed Income Global Bond Fund JP Morgan Global Government Bond Index - currency unhedged Global Bonds and Currencies Tactical Bond Pool FTSE/TMX Canada Universe Bond Index Global Diversified Bonds First Asset Long Duration Fixed Income ETF* FTSE/TMX Long- Term All Government Bond Index Deflation Hedge Hedged Hedged Unhedged Hedged Hedged 2.7 years 7.5 years 7.9 years 7.6 years 15.2 years Duration Range 0-5 years 5-9 years 5-9 years 5-9 years >15 years Alpha Target (bp) Tracking Error Target (bp) These products are designed to correlate negatively to stocks

6 Source: Bloomberg, Global Asset Management. As of September 29, *First Asset Long Duration Fixed Income ETF is an exchange-traded fund managed by First Asset Investment Management Inc. Global Asset Management, a division of CI Investments Inc., acts as portfolio advisor. Table 4: Standard Performance Data As of September 29, 2017 YTD 1 Year 3 Year 5 Year 10 Year Since Inception Group/ Investment Inception Date (Annualized) JPMorgan Global Government Bond Index JPMorgan Emerging Market Bond Index Plus CI Global Bond Class F CI Tactical Bond Pool Cl F CI Canadian Bond Class F CI Short-Term Bond Class F First Asset Long Duration Fixed Inc ETF /29/ /28/ /17/ /17/ /17/ /17/ /11/

7 This commentary is published by CI Investments Inc. It is provided as a general source of information and should not be considered personal investment advice or an offer or solicitation to buy or sell securities. Every effort has been made to ensure that the material contained in this commentary is accurate at the time of publication. However, CI Investments Inc. cannot guarantee its accuracy or completeness and accepts no responsibility for any loss arising from any use of or reliance on the information contained herein. This commentary may contain forward-looking statements about the fund, its future performance, strategies or prospects, and possible future fund action. These statements reflect the portfolio managers current beliefs and are based on information currently available to them. Forward-looking statements are not guarantees of future performance. We caution you not to place undue reliance on these statements as a number of factors could cause actual events or results to differ materially from those expressed in any forward-looking statement, including economic, political and market changes and other developments. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Unless otherwise indicated, the indicated rates of return are the historical annual compounded total returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. First Asset Investment Management Inc., manager of First Asset Long Duration Fixed Income ETF, is an affiliate of CI Investments Inc.