Emerging Market Debt: Smoke but no fire November 2014 Edwin Gutierrez, Head of Emerging Market Sovereign Debt Aberdeen Asset Management For Professional Investors only Not for public distribution
Smoke has masked the true picture in emerging markets this year 1
Despite all the noise returns have generally been solid in EM YTD total returns across asset classes (%) EM Local Sov. 1.56% EM Hard Sov. 9.87% US Treasuries 4.85% EM Equities 3.97% US IG Credit 7.02% EM Corporates 7.21% US High Yield 4.74% US Equities 10.99% 0% 2% 4% 6% 8% 10% 12% Source: JP Morgan, 31 Oct 14. For illustrative purposes only EM Local Sov: JPM GBI-EM GD, EM Hard Sov: JPM EMBI GD, EM Equities: JPM EM Free, US IG Credit: JPM JULI, EM Corporates: JPM CEMBI BD, US High Yield: JPM HY, US Equities: S&P500 2
Currencies have underperformed in the face of dollar strength % 110 JPM GBI-EM GD (local bond returns) JPM GBI-EM GD FX Return (unhedged in USD) JPM GBI-EM GD Total Return (unhedged in USD) 105 100 95 90 85 80 dic 12 giu 13 dic 13 giu 14 Source: JP Morgan, 31 Oct 14 For illustrative purposes only 3
but weaker FX precluded a crisis in 2013 Index returns from peak to trough (%) % 0-5 -10-11.4 Spread change over USTs from trough to peak (bps) bps 1'000 900 800 700-15 -29.8-28.9 600-20 500 400 895-25 300 633 200-30 -35 Russia crisis (1998) Lehman crisis (2008) Fed tapering talk (2013) 100 0 111 Russia crisis (1998) Lehman crisis (2008) Fed tapering talk (2013) Source: JP Morgan. All figures were correct at the close of business on 18 Feb 14 Index used is the JP Morgan EMBI Global Diversified For illustrative purposes only 4
In fact EMFX has declined to levels last seen at the height of the GFC JP Morgan Emerging Markets Currency Index 115 110 105 100 95 90 85 80 gen 05 gen 06 gen 07 gen 08 gen 09 gen 10 gen 11 gen 12 gen 13 gen 14 Source: JP Morgan, Bloomberg, 29 Oct 14. For illustrative purposes only 5
and has been positive for the EM trade balance EM trade balance (% of GDP seasonally adjusted three month moving average) 5% 4% 3% 2% 1% 0% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: Emerging Advisors Group, 20 Oct 14 Data covers 40 major EM economies. For illustrative purposes only 6
EMBI GD Brazil South Africa Indonesia Turkey India GBI-EM GD Brazil South Africa Indonesia Turkey India Index FX BRL ZAR IDR TRY INR which means the fragile five was last year s story % 2013 YTD 2014 20% 10% 0% -10% -20% -30% Fragile five hard currency bond returns Fragile five local currency bond returns Fragile five FX total returns 16.7% 15.2% 13.2% 11.5% 11.8% 9.2% 9.5% 9.6% 7.8% 7.9% 6.6% 4.3% 3.7% 1.7% 1.9% -0.1% -5.3% -4.3% -5.5% -6.9% -8.9% -8.6% -7.5% -6.7% -11.2% -11.8% -10.8% -12.6% -13.6% -14.7% -17.3% -18.5% -20.8% -31.2% -2.5% 8.2% -40% Source: Bloomberg, 21 Oct 14 For illustrative purposes only 7
Indonesia 5th Bangladesh and elections have generally been market positive this year Legislative Presidential Referendum Brazil: Post elections we expect to see more orthodox economic policy India: NDA coalition majority win supportive for reform efforts and investor sentiment Indonesia: PDI-P s Jokowi, the market favourite, wins the presidential election, but will face an opposition which holds a majority in the parliament Latvia 4th South Africa: ANC won 62% of the total votes in line with expectations. The EFF party won 6% of the vote, slightly above expectations, but won t force ANC to become more populist Turkey: Erdogan wins the Presidency, with the current economic team retained 1: The Economist, 6 Jan 14 Source: Electionista, 6 Jan 14. For illustrative purposes only 42% 1 of the world s population will vote in national polls in 2014 8
Although EMD has done well, valuations still stand out EMD - twice the yield of peripheral Europe % 8.0 EM LC Sovereign EM HC Sovereign EMU Periphery 7.0 6.0 5.0 4.0 3.0 2.0 2012 2013 2014 Duration (years): 4.8 (EM LC Sovereign) vs. 6.6 (EM HC Sovereign) vs. 6.4 (EMU Periphery) Rating (S&P): BBB+ (EM LC Sovereign) vs. BBB- (EM HC Sovereign) vs. BBB (EMU Periphery) Source: JP Morgan, 6 Nov 14. For illustrative purposes only EM LC Sovereign: GBI-EM Global Diversified; EM HC Sovereign: EMBI Global Diversified; EMU Periphery: EMU Peripheral Bond 9
and real yields are particularly compelling relative to developed markets Conventional bonds 10 year bond yield (%) Inflation y-o-y (%) Real yield (%) Brazil 12.6 6.8 5.9 BBB+ Indonesia 8.0 4.8 3.1 BB+ Poland 2.7-0.3 3.0 A Colombia 6.0 3.3 2.7 BBB+ Peru 5.5 3.1 2.5 A- UK 2.3 1.2 1.1 AAA US 2.4 1.7 0.7 AA+ Germany 0.8 0.8 0.0 AAA Japan 0.5 3.2-2.7 AA- Index linked bonds 10 year bond yield** (%) Inflation y-o-y (%) Real yield (%) Brazil 12.7 6.6 6.1 BBB+ Uruguay 11.6 8.1 3.5 BBB- Mexico 6.9 4.2 2.7 A Credit rating (S&P)* Credit rating (S&P)* Source: S&P Local Currency Debt Rating, Bloomberg, 7 Nov 14. For illustrative purposes only * Standard & Poor s credit ratings are expressed as letter grades that range from AAA to D to communicate the agency s opinion of relative level of credit risk. Ratings from AA to CCC may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories. The investment grade category is a rating from AAA to BBB- ** Implied nominal yield Indexes are unmanaged and have been provided for comparison purposes only. No fees or expenses are reflected. Individuals cannot invest directly in an index. 10
Meanwhile, EM fundamentals are stronger than they were 10 years ago International reserves (as % of GDP) % 2002 2013 45 40 35 30 25 20 15 10 5 0 Brazil China Mexico Peru Russia South Korea Source: IMF, Apr 14 For illustrative purposes only 11
and debt levels have improved dramatically Net external debt Net external debt (% of GDP) 60% Public debt Gross public debt (% of GDP) 70% 50% 60% 40% 50% 40% 30% 30% 20% 20% 10% 10% 0% 1970 1980 1990 2000 2010 0% 1970 1980 1990 2000 2010 Source: Emerging Advisors Group, 31 Jul 13. For illustrative purposes only Data covers 40 major EM economies 12
EM high yield corporates remain less levered than US counterparts High yield leverage trends: EM vs US 5.0 4.5 EM HY Leverage US HY Leverage 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 mar 09 giu 09 set 09 dic 09 mar 10 giu 10 set 10 dic 10 mar 11 giu 11 set 11 dic 11 mar 12 giu 12 set 12 dic 12 mar 13 giu 13 set 13 dic 13 giu 14 set 14 Source: BofA Merrill Lynch Global Research, 30 Sep 14. For illustrative purposes only Leverage = Net Debt/EBITDA 13
Oct 08 Feb 09 Jun 09 Oct 09 Feb 10 Jun 10 Oct 10 Feb 11 Jun 11 Oct 11 Feb 12 Jun 12 Oct 12 Feb 13 Jun 13 Oct 13 Feb 14 Jun 14 Oct 14 Feb 15 Jun 15 which means that EM HY default rates are not higher EM HY vs. US HY default rates % 16 US HY EM HY 14 12 10 8 6 4 2 0 Source: BNP Paribas, Jun 14 For illustrative purposes only 14
Once you get past the smoke, the long term returns remain impressive 10 years benchmark risk and returns Benchmark annualised returns USD (%) 12 11 EM Equities 10 EM Frontier 9 8 EM HC Sovereign US HY EM LC Sovereign US Equities 7 6 US IG Corporate EM Corporate 5 4 US Treasury 0 5 10 15 20 25 30 Annualised volatility (%) Source: JP Morgan, 30 Sep 14. Past performance is not indicative of future results. For illustrative purposes only Benchmarks used: US Treasury = JPM GBI US, US IG Corporate = JPM JULI, EM Corporate = JPM CEMBI Broad, US High Yield = JPM US HY, EM HC Sovereign = JPM EMBIG, EM LC Sovereign = JPM GBI-EM GD, EM Frontier = JPM NEXGEM, US Equities = S&P 500, EM Equities = EM Free 15
Retail flows only tell a small part of the story EM debt flows (US$bn) 40 IIF EPFR 30 20 10 0-10 -20-30 gen 10 lug 10 gen 11 lug 11 gen 12 lug 12 gen 13 lug 13 gen 14 lug 14 Since 2010 there have only been two months of debt outflows from emerging markets Source: EPFR, IIF, 30 Sep 14 For illustrative purposes only 16
Institutional inflows should support EMD markets over the long term Global diversified portfolio exposure to EMD (% total) 5 4 3 2 4.0 1 2.5 2.4 1.0 0 North America (Canada/US) Europe Asia Latin America Institutional investors remain structurally underweight and will continue to look to EM bonds to diversify their exposure away from core developed bond markets Source: Morgan Stanley, 10 Jan 14 For illustrative purposes only. This does not represent any Aberdeen portfolios 17
Summary Perceptions are often counter to reality in emerging market debt Although EMFX has underperformed, this has helped reduced overall volatility in the asset class EMD is supported by better fundamentals than developed markets EMD offers attractive return opportunities Inflows are structural and should remain steady amid search for yield 18
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