Three emerging market experts offer their thoughts on the sentiments of European fund selectors towards emerging market bonds and equities over the next 12 months. The sentiment data was published by Expert Investor‘s publisher Last Word Media in the third quarter of 2019.
Global emerging market equities
Source: Last Word Research
Philip Lawlor, managing director for global markets research at FTSE Russell, said:
“Emerging markets have underperformed developed markets in 2019 to date, where the US has driven major gains for investors on the back of record highs for the Russell 1000 index.
“Contributory factors behind this underperformance include concerns about the vulnerability of emerging market corporate profits and the appreciation of the US dollar, due to their dollar-denominated debt exposure.
“Emerging markets have not enjoyed the same upward momentum since the 2008 financial crisis ended a 10-year bull market for equities that has yet to return in force. The make-up of the FTSE Emerging index has also changed fundamentally over that period – both from a sectoral and country allocation perspective – with China-linked stocks now registering a dominant position in the index.
“The transition away from a low-margin manufacturing and export economy to a services sectors, such as financials and technology, is also leading to significant sectoral allocation changes within the FTSE Emerging index.”
Emerging market government bonds*
Source: Last Word Research * Note: Emerging market sovereign and corporate flow data are merged
Liam Spillane, head of emerging market debt at Aviva Investors, said:
“The recent shift in the data towards a more neutral stance in individual country sentiment reflects strong returns from emerging market debt asset classes, heavy investor demand over the last couple of years – especially for hard currency sovereigns – and some uncertainty around the global macro backdrop.
“While investors have experienced strong risk-adjusted outcomes at times [for emerging market debt funds], it is prudent to reconsider asset allocation preferences.
“Investor appetite for emerging market sovereigns over the last couple of years has been very strong.
“Around three-quarters of investor flows have been allocated to hard currency sovereigns versus one quarter to local currency sovereigns. Perhaps the most interesting trend to observe going forward will be how the asset allocation between the two shapes up.
“The shift to a more neutral stance in the data shown is reflective of the maturity and, to a degree, the success of that hard currency preference and allocation in terms of risk-adjusted returns over the course of 2019.
“While we have positive total return expectations for both local and hard currency sovereigns, the relative valuation argument is more compelling in local currency.
“Very recent flow data suggests we may be seeing the early signs of a shift in asset allocation preferences accordingly.”
Robert Reichle, head of global and emerging markets at Berenberg, said:
“After a strong recovery in Q1 of this year and still a solid Q2, albeit starting to consolidate, we have seen outflows in the emerging market sovereign space, particularly in October and November. This was due to the coinciding effects of profit-taking by investors who had already had a very good year and, at the same time, increasing volatility – especially in Latin America.
“Looking at the broader picture, going into the new year, on the sovereign side, markets are fairly priced at present.
“Therefore, we would consider ourselves as cautious, as, in our opinion, markets have become more heterogeneous, and are also facing various political uncertainties, such as the ongoing US-China trade conflict.”
Emerging market corporate bonds*
Source: Last Word Research *Emerging market sovereign and corporate flow data are merged
Frederic Waterstraat, portfolio manager emerging markets at Berenberg, said:
“We agree on the individual country sentiment shown above. Within the asset class of emerging markets corporates, we would position ourselves neutral to positive – compared to sovereigns – due to the currently more attractive risk-return profile.
“In addition, the emerging markets corporate market is becoming more and more supported in terms of investors’ recognition of a market segment that offers robust returns despite an overall bumpier road in emerging markets in general in the upcoming quarters.”
Liam Spillane, head of emerging market debt at Aviva Investors, said:
“Demand for emerging market corporates has certainly increased in recent years. That demand, however, is likely to be far smaller than demand for emerging market sovereigns given the materially different size and structure of the respective investor bases and investable universes.
“That said, there is a growing awareness and understanding of the benefits of the asset class.
“The investable universe for emerging market corporates is growing at the fastest rate across the emerging market debt spectrum. It is approximately twice as large as the hard currency sovereign space and a quarter of the size of the local currency sovereign universe. This suggests structural demand for the asset class will continue to grow.”
