Investment Strategy On-Demand Webinar Series

Transcription

1 Investment Strategy On-Demand Webinar Series

2 U.S. Dollar Emerging Market Debt Jas Thandi, Hewitt EnnisKnupp

3 USD Emerging Market Bonds Have Cheapened Relative to U.S. Bonds 10 Emerging bonds have cheapened relative to US bonds Yield (%) EM bond yields have risen more than US bond yields EM hard currency sovereign bonds US investment grade bonds US high yield bonds Source: JPMorgan, BofA ML 2

4 EM Economies are Facing Some Challenges 12% The fragilities of the fragile five 10% 8% 6% 4% 2% 0% -2% -4% -6% -8% -10% Brazil India Indonesia Turkey South Africa Current account/gdp Inflation Source: IMF EM economies in aggregate are expected remain in current account deficit and growth has slowed Economies with high current account deficits and high inflation are forced to raise interest rates 3

5 We Believe the Weakness in EM Economies is Overstated 7 Emerging economic growth expected to pick up 6 EM growth rates (%) Source: IMF, October JPMorgan. Weighted by 20 largest sovereign bond markets Floating currencies, lower external debt levels, higher currency reserves and better fundamentals put EM economies on a stronger footing to deal with a U.S. tightening policy than in the 1990s We believe that EM economies will start to recover from this difficult period: EM economic growth is expected to pick up Rising interest rates and inflation are not such a significant threat as some believe More competitive exchange rates will help EM recovery 4

6 EM Corporates Balance Sheets Remain in OK Shape EM company net leverage is lower than in the US A Credit rating BBB BB B US EM Source: BoA/ML The balance sheets of EM corporates have deteriorated which has been reflected in falling credit ratings Leverage levels have increased, driven by a fall in earnings and companies issuing more debt to take advantage of low yields. We do not expect default rates to rise significantly as company fundamentals overall look firm 5

7 We Believe EM Spreads are Unlikely to Rise Further Rising yields and a narrowing EM yield spread tend to coincide Periods of rising U.S. yields shaded in blue 8 % 6 4 Historic averages EM corporate credit spread EM sovereign credit spread Source: Datastream, JPMorgan There are number of factors applying upward pressure to EM spreads: Negative credit rating outlook High levels of political risk and slower growth may delay anticipated structural reforms However, there are forces applying downward pressure on spreads: Economic recovery and rising U.S. yields typically coincide with falling spreads A lot of the bad news is already priced in 6

8 EM Bonds are Attractively Valued Compared to U.S. Credit EM credit spreads over US credit are close to 10 year highs 1.5% Spread over US corporate yield 1.0% 0.5% 0.0% % -1.0% -1.5% EM corporates EM sovereigns Source: JPMorgan Against U.S. credit, EM spreads are at levels not seen since 10 years ago Taking into account the improvement in EM credit worthiness we think valuations are attractive We believe that spreads are at sufficient levels to absorb the impact of rising yields, and help EM outperform U.S. credit and Treasuries 7

9 We Expect EM Hard Currency Bonds to Return 4 5% Per Year Expected annualized returns over the next 3 years 6% 5% 4% 3% 2% 1% 0% Strong global economic recovery Central scenario Higher global risk aversion Source: Aon Hewitt EM sovereigns EM corporates Our central scenario is based on our expectations for U.S. treasury yields to rise over the next three years and a 0.5% narrowing in EM hard currency spreads over U.S. treasury yields The economic recovery scenario assumes both developed and emerging economies grow strongly and consequently U.S. yields rise by 1% more than we expect over the next three years and emerging hard currency spreads contract by 1% The risk aversion scenario assumes 0.5% lower U.S. yields than we expect and a 1.3% spread widening (back to 2011 highs) 8

10 Conclusions We still prefer local EM debt to EM hard currency debt over a medium-term horizon Given local EM debt s higher yield levels and lower sensitivity to developed market yields Both EM sovereign and corporate hard currency bonds have now become attractively valued relative to the broader fixed income universe. We expect credit spreads over U.S. treasuries to narrow However, we expect that volatility will remain driven by economic, policy and political uncertainty We expect EM hard currency bonds to return around 4 to 5% per year over the next one to three years Current spreads are at sufficient levels to absorb the impact of rising yields and post positive returns over the next three years. 9

11 Contact List Jas Thandi, Senior Consultant Global Asset Allocation

12 Legal Disclaimer Copyright 2014 Hewitt EnnisKnupp, Inc. This document is intended for general information purposes only and should not be construed as advice or opinions on any specific facts or circumstances. The comments in this summary are based upon Hewitt EnnisKnupp's preliminary analysis of publicly available information. The content of this document is made available on an as is basis, without warranty of any kind. Hewitt EnnisKnupp disclaims any legal liability to any person or organization for loss or damage caused by or resulting from any reliance placed on that content. Hewitt reserves all rights to the content of this document.