A flawed traditional approach
Historically investors have categorised the world into emerging markets (EM) and developed markets (DM) without regard for underlying fundamental risks. They typically see EMs as the poorest and most risky regions in the world, while DMs are considered more wealthy and much less risky.
However, this is an antiquated view and overlooks the fundamental shift in the underlying economic structure of emerging countries. Many of these traditional EM risks are now present in so-called DMs.
We no longer adhere to this traditional belief. Many DMs now face high debt levels, weak current accounts and political risk, while many EMs benefit from fiscal sustainability, current-account surpluses and monetary-policy credibility.
Shifting economic influence
From a global, political and economic perspective, many EMs now wield significant clout, and are not simply reliant on DMs.
Antiquated classification of countries creates investor segmentation which when considered in combination with flawed benchmark construction (see 1. The hidden risk in debt benchmarks) can lead to mispricing of risk. For those who assess risk and return and not simply market labels, there are opportunities to be exploited.
Reassessing debt sustainability
The economic lessons learned by many countries at the end of the 20th century have resulted in more sustainable debt profiles and although this has been in part reflected in ratings, there remains an observable market discount for equivalent agency ratings when comparing EM and DM credits, particularly when considering countries with better credit.
Developed market debt has burgeoned while emerging markets have maintained more moderate debt burdens
Developed market risk
At the other end of the spectrum, there are still traditional EM stories of default risk, political instability and unsustainable debt practices. However, some of these risk attributes, most notably over leverage, also exist in so-called DMs.
As the experiences of Iceland, Greece and Portugal have shown, countries considered developed are often vulnerable to debt crises in a similar way to emerging countries. Distinguishing between EM and DM no longer separates countries facing credit risk from those that don’t.
Avoiding structural biases
We aim to take an objective view and avoid behavioural and structural biases. Screening processes such as our ‘Net Foreign Assets’ (NFA) model aim to take an agnostic view of classification and distinguish between creditor countries with stronger financial profiles and debtor countries with excessive liabilities.
In fact when countries are ranked in order of NFA the distinction between EM and DM is opaque and leads us to question whether or not associated risks are appropriately priced.
Links to fund pages
- New Capital Global Value Credit Fund
- New Capital Wealthy Nations Bond Fund
- New Capital Asia Value Credit Fund
- New Capital Euro Value Credit Fund
- Institutional strategies
To explore the relative value approach that underpins our credit selection read our whitepaper A Theory of Relativity.