A shift of inflows into emerging markets at the start of September accelerated in October, according to Warren Hyland, portfolio manager at Muzinich & Co.
His team believes investors and allocators currently have more interest in EM than they did in H120 for three main reasons.
Namely; better growth, no liquidity issues and good market sentiment.
Full speed ahead
“Emerging markets are currently attractive to investors because they seem to be recovering from the coronavirus and are showing high growth,” Hyland says.
“China’s sequentially strong growth numbers has, in fact, surpassed its pre-covid-19 levels, working at full speed again.
“The International Monetary Fund has recently estimated that China’s contribution to global GDP growth will increase to 26.8% in 2021.
“This has had a secondary knock-on effect on the Asian region and in the commodity sector in Latin America and the Middle East, which has led to increased confidence for EM.”
Hyland adds that growth areas, such as trade and manufacturing “are back to normalised levels, and economists and forecasters predict that EM will grow faster than western markets and recover more quickly”.
Less interest-rate correlated
Looking specifically at EM debt; Dimitry Griko, chief investment officer, fixed income at EG Capital Advisors, says that “valuations look very attractive versus other asset classes that have rallied quite significantly since the peak of the covid crisis”.
“Pockets of value still exist and look even more attractive given the expectations of a more pronounced economic rebound within EM next year.
“Hunt for yield and diversification away from DM risks continue to support EM debt. Uncertainty about interest rate reaction economic rebound in 2021 attracts investors to less interest-rate correlated subclasses; such as EM corporate high yield, which tend to perform better during periods of economic growth.”
Swerved the potholes
When it comes to EM investing; liquidity is always a concern.
But Hyland says, compared to 2008, “the current covid-19 crisis is not a banking crisis and the banking system is fully operational and providing funding for corporates and sovereigns”.
“Thus, EM countries are able to fund themselves during the crisis.”
Add to that the Biden bump, in the sense that the president-elect is expected to be “less confrontational on trade” than Donald Trump; Hyland and his team view a Biden government as “more favourable for EM”.
“Furthermore, it is expected that a Biden administration will be much more generous with fiscal spending than the Republicans.
“Therefore, the US will have more to spend and will buy more goods from EM. As US debt rises from fiscal looseness, an investor must be compensated, which is usually through yields and treasuries which have been set by the central banks.
“The only other way to do this is through a weaker currency. The weakness in the US dollar is typically seen as a strong sentiment driver for the EM asset class,” Hyland adds.
Economic rebound expectations
For EG Capital Advisors’ Griko, “the corporate space overall looks extremely interesting”.
“Over the past couple of years, we have seen divergence of sovereign risk from corporate risk with quite a lot of the latter often being safer and less dependent on the macroeconomic picture.
“This year’s flows support that, and we expect the trend to continue,” he says.
“Riskier, lower-rated corporates are looking much more attractive on the risk-reward basis. The recent rebound from the covid selloff has not been as pronounced as it was in higher quality names with investment grade spreads being close to historic tights.
“Meanwhile, high yield is still close to historic wides, leaving a lot of potential for catching up.”
When it comes to what the landscape looks like for EMD in 2021, Griko says, “given the expectations of an economic rebound, strong bids are bound to continue supporting the market throughout the next year”.
“However, until we fully know the damage done by the pandemic, security selection and risk management are going to be key.”