Frontier markets: A high yield credit opportunity?

While attractive yields remain, we discuss why asset selection and awareness of upcoming global events are crucial within emerging market debt. 

Transcript

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Karen Bater

Hello, everybody. I'm Karen Bater from Abrdn and you're listening to the Emerging Market Debt Quarterly podcast show that looks at what happened during the recent quarter and provides our outlook for the asset class going forward. Today, I'm joined by my colleague Brett Diment, head of Global Emerging Market Debt. Brett, welcome to the podcast. It's really great to have you on.

Brett Diment

Great to be with you, Karen. 

Karen Bater

Well, a lot is going on in the emerging markets over the last quarter and certainly it's been an interesting one in the first quarter. Would you be able to remind us of the key drivers of performance over the quarter that you would like to share? 

Brett Diment

Yeah, sure. As you say, it's been certainly an interesting three months since the start of the year in emerging market fixed income. If you look at the overall returns positive to the two, the three main segments of the asset class. So that's the global diversified. That's the sovereign US dollar index up 2% and EM corporates also up just over 2%. We have seen a bit of weakness in local currency. So local currency was down 2%. Within that, the broader theme saw some really strong returns from the high yielding credit part of the asset class.

So if you look at high yield sovereigns, for example, up almost 5%. High yielding corporates up over 4%. In contrast, as we saw that the move higher in in US Treasury yields that led to actually negative returns and investment grades down about the sense of the sovereign benchmark and up about percent for investment grade and corporate. So yes on balance, positive, but some you know, some quite interesting development within that.

 Karen Bater

Great. That's really interesting. Thanks for sharing. Can you talk a little bit more about the higher yielding space, in particular Frontier, where I know you have a core expertise at Abrdn and how has that impacted the performance of the fund? Are there any special situations you like to share with us? 

 Brett Diment

Yeah, sure. So yeah, we kind of yeah, last year was in last year we already start to see some, some performance, some high yields. Frontier in particular. And that has continued into the first quarter of this year. So, for example I have a credit such as Zambia is up almost 20% similar returns with similar terms with Ghana which also like Zambia is a frontier credit Pakistan at 27%. So generally, some pretty strong returns from the frontier names. So a couple of couple of developments there.

Yeah. First of all, we're really moving ahead with a couple of really the major sovereign debt restructurings in Zambia and Ghana. And I think that's given investors some comfort that countries can work through these stress situations. And that's helped not just to reprice those countries but to high yield frontier names more generally. And also the market is now think about whether or not to trade once they come out of that debt defaults.

And there is probably going to be a lot lower than the sort of yields people were talking about start the year, maybe around 11, 12% or so, I'd say. The other key development in frontier space has been we've seen that countries come to the markets, so we've seen Kenya come to the markets with the new issue during the quarter.

And obviously the fact that so we can now see issuance really, really takes the pressure, particularly off some of the shorter term debt maturities. So that's that that's helped us. That's helped us. While, you know, generally if you look at the relative returns for our strategies, we've been up a percent or so relative to the benchmark in the in the quarter.

And certainly that that kind of overweight frontier has been a significant contributor to that. 

Karen Bater

Well, it's nice to see that's one of our key drivers and it really added to performance for the period. I know you talked a little bit about local and there's been changes in the local dynamics. Would you be able to expand on that a little bit for the listeners?

Brett Diment

Yes, I'd say it's a couple of things in local markets. First of all, yes, it's somewhat stronger dollar against some local currencies. Some of the Fed rate cuts have been have been priced out. And also as growth has remained robust across Asia, then you've seen also rate cuts priced out in some of the emerging markets, particularly in Latin America.

But a lot of it's been about asset selection. So even though we saw weakness overall in local currency on a relative basis, we have added value for our strategies, the local currency, the benchmark. That's because we've been underweight, you know, some of the worst performers. So Chile, for example, we saw another weakness in the Chilean peso that was down about 12%.

We're underweight Chile, Thailand down 4%, whereas a country, Uruguay, the other side of that was up almost 10%. We were overweight Uruguay debt. So overall negative local markets, but certainly Spain, a market where, you know, country selection has been very important. 

Karen Bater

Well, that's great. Very interesting. Again, so I guess this brings us to a part of the conversations. We've had great performance in 2003, followed by a fairly strong EMD market in the first quarter, led by Frontier in the higher yielding sector to the marketplace. There's been a lot that's changed with Fed policy, inflation, geopolitical events and elections. So I guess now would be a great time to turn over to Outlook and what we're thinking about for EMD in the second quarter and beyond. Would you be able to give us your thoughts there on all those hot topics? 

Brett Diment

Yeah, sure. I think, you know, one emerging countries we haven't mentioned so far is China, which generally quite light in exposure to Chinese risk really across all EMD's strategies I'll call you that, is that Chinese growth will remain pretty sluggish. There are still some major issues in the in the real estate sector, you know, and actually we don't think that's necessarily bad for the rest of the emerging markets because sluggish Chinese growth will mean that Chinese inflation remains very subdued.

We actually saw deflation in China at the start of last year. So that, you know, the fact that Chinese growth is going to be sluggish will help keep down to a certain extent, broader emerging market growth. I think within local markets, asset selection's still going to be really important. One of the one of the core countries we think is interesting is India obviously got the Indian election upcoming.

Modi will win it a strong majority there. He's really kind of pushing ahead with reform, which is supporting FDI into India, will support the fact. So in India, we think will continue to be an interesting space. I think in terms of the Fed, yeah, you've already said a lot of the rate cuts priced out, the market having, you know, priced in about, you know, five, five cuts by the Fed for 2020 for the of this year.

You know, most of that's not been priced out. You know, just pricing, you know, two or three cuts by the Fed. So I think kind of a move higher in in US Treasury yields from here. Is it less the risk? Of course, one factor that I think investors are already starting to focus on is the upcoming election in the US, in the US.

And I think that's going to have mixed implications across the. So obviously again, asset selection is going to be going to be pretty key to 

Karen Bater

I guess as we kind of bring the podcast closer to a close. And you've described a lot of events that you're looking forward to in your outlook. How are you thinking about allocations to EM at this time?

Brett Diment

Yeah, look, I think if you if you stand back, look at the asset class, you know, we still have some, some pretty attractive yields because even though even though spreads declines, you know, the fact that risk free rates went up means that actually if you look at the yield on the global diversified to the sovereign US dollar index, then it declined ten basis points over the quarter.

So that's yielding about 7.8%. Frontier is about 6.7% and local markets 6.3%. So you still have some interesting yields in EM. You know, we'd expect continued strong performance from the frontier names as these kind of restructured plays actually start to start form again. But, you know, as ever in emerging markets, asset selection is going to be it's going to be really is going to be really important because, you know, you're always within the overall asset class, always going to see some some some some countries that generate some quite large positive returns and also some countries that can generate, you know, negative returns, which so asset selection will it will clearly remain quite key.

Karen Bater

Well, on that upbeat note, it feels like a good place to bring this podcast to a close. Thank you, Brett, for joining us today. Great job. 

Brett Diment

That's great. Thanks, Karen, and look forward to catching up next quarter. 

Karen Bater 
And thank you to everyone who took the time to listen in today. If you enjoyed what you heard, please download our other podcast from our website or where you normally get your shows and have a great day everyone.

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This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for informational purposes only and should not be considered as an offer, investment recommendation or solicitation to deal in any of the investments or products mentioned herein and does not constitute investment research. The views in this podcast are those of the contributors at the time of publication and do not necessarily reflect those of Abrdn.

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