Emerging markets: Frontiers, high yields, and restructurings

Discussing the quarter that was in emerging markets debt and more.

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 Karen Bater

Hello, everybody. This is Karen Bater from abrdn, and you're listening to the Emerging Market Debt Quarterly podcast, the show that looks at what happened in the recent quarter and provides our outlook for the emerging market debt asset class. Today, I am joined by my colleague Brett Diment, Global head of Emerging Market Debt. Brett, welcome to the podcast. It's great to have you on.

Brett Diment

Well, great to be on with you, Karen. Thanks very much. 

Karen Bater

Well, so much has happened in the financial markets in the first half of 2024. And specifically, we know that the fed is driving returns inflation, political challenges both here and abroad. Can you comment on the performance in the second quarter and the first half across our EMD strategies? 

Brett Diment

Yeah, of course, of course, Karen, that'd be a pleasure.

So I'd say it was certainly a mixed and mixed quarter. so we saw some good returns, in corporates, corporate indexes, sent to the half or so in the, in the quarter, funds were 30 basis points or so ahead of that, a bit more muted. for, hard currency, sovereigns up about 30 basis points. Our strategies were, were flat, where we saw, weakness was in local currency, benchmark down about 1.5%. and we were at bottom about half percent or so. below that benchmark. In terms of the, the year to date figures, as my ramped up generally pretty good, pretty good, pretty good start to the year.

Pretty good Q1. So generally, positive, for hard currency strategies on the year. Quite decently. So, so up, up 4% for corporates, we're about 50 basis points also ahead of that, a 2.5% or so, so hard currency sovereigns. Our strategies are about 3%. And again, where we've seen the weakness is in local currency, with the, with a benchmark and our funds down about 4% or so.

So really? Yeah. Overall a good, the good kind of, kind of year to date for, credit to the high yield credit where you see weakness has been in the local currency. So the non dollar markets. 

Karen Bater

Well that's great news. I know it's been a challenging environment in the first half of 2024. And there's a lot of consequences that we're managing in the marketplace. With respect to the strategies both the corporate as well as the hard currency and local currency strategies. Could you comment on some of the key drivers, both contributors and detractors, that you would like to share with our viewers? 

Brett Diment

Yeah, I'd say yeah. Contributors. to the on the corporate side, generally we've seen we've seen better value in the, in the high yield sector, actually particularly the double B sector.

 So that's been, that's been a clear contributor in terms of, of the sovereign hard currencies, know both for our broader strategies, but also frontier, which is a real focus for us. Then we've seen some of those, you know, long debt restructuring has come through. So Zambia, for example, they had that debt restructuring. Agreed. That's been positive for us almost over the line in Ghana.

That's been a positive in terms of detractors. That's been more on the on the local currency side. you know, generally, we see inflation, coming down across the emerging markets. You know, the markets have been negatively impacted by what's happening in US treasuries. So we've seen some pressure higher in some of the local bond markets, particularly in, in Brazil, which has been one of our, one of our overweight and some fiscal concerns to me through there.

So I'd really highlight, Brazil level currency has been one of the main detractors. 

Karen Bater

That's excellent. within some of the local drivers though, would you be able to come on, how much was driven by political events in EM? And are there any specific countries you would like to highlight with respect to our positioning and how we did in the first half, relative to the political drivers in the marketplace?

Brett Diment

Yeah, sure. Excellent question. Karen. You know, obviously, yeah. Politics is a key driver, in emerging markets. And, you know, one thing that we, we spend a lot of time on is analyzing political risks, speaking to, to local investors and local analysts. And you know, we have to be able to react quickly to those developments and I'll, I'll perhaps highlight, three countries.

The first of those would be South Africa. So we had the African election. We came into, into that, pretty light of, pretty light of race, a pretty, pretty kind of benchmark, like in terms of of our South African bond holdings, the local currency bond holdings. The election result, came out quite inconclusive. So the ANC, which has had an offensive, ruling a majority really since the end of apartheid in the mid 90s, they lost that majority.

 We thought, after that election, we saw some weakness in the market due to that uncertainty as to what would happen. Our strong view is, would there would be a coalition and the, the, the kind of the market, friendly Democrats aligned to be part of that coalition. So actually, the day after those election results came out, we actually, took an overweight position in Rand bonds and that's, that's, that's come through.

There has been a coalition. So that occurs. So actually, so African bonds did very well. And actually over the quarter rand, local currency bonds were up 11% or so. In contrast, in Mexico, actually, the incumbent party, did. Well and actually better than we expected in the congressional elections. So, the incumbent party got what's called a supermajority so you can change, parts of the Constitution.

And we came into those elections, with a modest overweight in the, in the Mexican peso, you know, really seeing mask benefiting from some of those nearshoring. trends we've seen globally. With that supermajority, we thought, you know, there was there was a risk of some adverse, measures that may impact the judiciary. So actually, on the same day that we had those African results, we had the first trading day post of Mexican results, and we moved from an overweight to neutral position in the Mexican peso.

And subsequent to that, we've seen some weakness in the peso. and the third election highlights is, is India, so Modi, the Indian prime minister did worse than expected, in those elections, you know, we'll have to work in, in a coalition. You know, we see that as relatively, relatively, relatively positive. we think some of the reform measures will continue.

So we've, we've we we kept our overweight in India, in the local currency, local currency, bonds, where we have exposure to the, the effect. So India is up about 2% or so. So, you know, politics, across the air is an important factor for us to, to watch. 

Karen Bater

Well, that's very distinct. Thank you for your views. I think looking back to the first quarter and also in 2023, there seems to be there seems to be a little bit more, performance drivers from the higher yielding or frontier space. It seems to be a little bit more differentiated in the second quarter. Would you be able to comment on frontiers in high yield issuers? What and how what and how they contributed to performance in the second quarter and how we're thinking about them for the second half?

 Brett Diment

Yeah. So, you know, as I touched on, you know, kind of really, really, really key development is that, you know, we did see some sovereign credit distress around Covid. And, we've had a number of countries working through that. And, yeah, we've we've, you know, we've really got restructurings completed in Zambia now. Ghana, that is, that is ongoing as we speak.

We think, Sri Lanka could be next. So, you know, we'd say that generally is quite positive for the overall, frontier high yielding, asset class. But you know, we we also need to be fairly, you know, fairly nimble in terms of how we approach, you know, just the broader high yield sector. So Argentina, a country that, you know, certainly has done very well over the past, the past 12 months or so, with, a very, very significant fiscal tightening put in place.

We tops list our overweight position there still see Argentina as relatively attractive but just thought it was a prudent to top slice that, you know, more recently, you know, we've seen, some issuers come back into the, into the high yield market. Egypt got a very large support package, so wouldn't be surprised to see Egypt, issuing at some stage.

But, yeah, you know, a lot, lot going in in that sector. And broadly speaking, you know, we still think there's some very interesting opportunities there. 

Karen Bater

Well, thank you for your comments there too. One thing that's I think on everyone's mind is the changing, changing fed and potentially dovish fed in the second half and how that is going to impact EMD and performance for local markets and effects would seem to be a little bit more muted in the second quarter of 2024. Do you have any thoughts on the fed and how that policy may shape EMD flows and performance in the second half of 2024? 

Brett Diment

Yeah, look, I think, you know, clearly for, for local currency, non dollar assets, you know, it's the dollar is strong. If the fed is you know it's tight that people expect that can be a negative. You know in terms of the fed as we, you know come into coming months. you know our expectation is I would say broadly in line with market pricing. So one, perhaps two rate cuts, from the Federal Reserve. And certainly if you look into some of the details of the employment report, we saw at the back end of last week, and, you know, we are starting to see some softening in the labor market.

You know, we would expect, the fact that the fed is, is finally starting to ease policy. Yeah, it should be politically constructive for local markets. not just, not just from a currency perspective, but also in terms of what's priced into those right markets. you know, we think the fed cutting will open the door up to, to rate cuts, from some of the, some of the emerging markets, countries, which will obviously help, help returns from those securities.

 Karen Bater

Well that's great. I have just two more questions and hopefully the audience will appreciate them both. And of course, I'm going to save the best for last. But we know China has a big impact on EMD and a lot is changing the landscape in China. Do you have any broad thoughts where you would like to share before I head to the final question?

 Brett Diment

Yeah, look, I, I'd say, you know, certainly looking at China, you know, certainly I guess my observation on that is that, you know, some of the challenges that China had are not unlike the challenges that Japan and the in the, in the, in the 1990s, where you see, you know, very significant ramp up in the real estate market, lots of leverage in the domestic economy.

And as that real estate market turns down, you know, really puts a big downward pressure on domestic prices. So we think, you know, China is going to see quite low inflation, in its own domestic economy. obviously Chinese exports, are rising globally. And, and while we're seeing some tariffs put in place for the US or Europe, you know, certainly as China export to other emerging markets, it will have a, an impact on inflation in those countries. 

So generally, see, Chinese weakness is, economic weakness is deflationary globally. In terms of the economic impacts upon other emerging markets. Well, actually, you know, I think we'd be relatively sanguine about that, partly because, you know, we've seen this nearshoring trend. So, you know, countries, neighboring countries in the region such as, you know, Thailand or Malaysia, reentered with orientation, taking their exports, towards, you know, Europe and the United States.

 And, you know, countries such as Chile or Brazil, we have big, copper ore and, iron ore exporters again, you know, the, you know, the move to the kind of green economy globally will help those metals. So actually see Chinese weakness as actually to, you know, generally supportive of the rest of EM and helps open the door to some of those write offs I was talking about earlier.

Karen Bater

That's great. So much exciting information and content for our viewers to think about. A lot of opportunity in EMD and certainly a lot of challenges, but it seems like we're very well priced and, a very interesting opportunity, at this time. So heading to my final question, last but not least, but certainly top of everyone's mind is the US elections. So I'm going to put you on the spot and ask you who and how it's going to impact EMD. 

Brett Diment

Yeah, so obviously we use political risk in emerging markets. So, I guess I guess, you know, a couple of observations. I would, I would give, I would say a Trump presidency is, you know, has certainly as that's been in the price and, you know, if you look at the reaction of emerging markets after the debate that, Trump and Biden had, a couple of weeks ago actually was a relatively muted reaction. Clearly, yeah. The probability of Trump winning the election went even higher after that, which I think says to me that Trump is is largely in the price in, in emerging markets, you know, perhaps was not in the price of you get a full sweep. 

Yeah. We could we could see perhaps a bit more dollar strength in a bit of a weakness. I mean, to my mind, and I'm sure, all our listeners have their own views on this. If anything, the risks are getting getting skewed. the other way, if, for whatever reason, the Democratic candidate were not to be Joe Biden would be someone else.

Then perhaps, perhaps the market, will start to price a high probability of a Trump not winning the election. And, I see that could be quite positive for certain emerging market assets. But, obviously this story is going to run and run, for the next week, a month. And I'm sure, I'm sure, we'll be keeping a very close eye on developments.

Karen Bater

Well, thank you very much. That feels like a good place to bring the podcast to a close. thank you, Brett, for joining today. We really appreciate your thoughts. 

Brett Diment

Great. Thank you, Karen.

Karen Bater

And thanks to everyone who took the time to listen in today. If you enjoyed today, then please download our other podcasts or our website or wherever you normally get your podcasts.

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