Alejandro Arevalo (Jupiter’s Head of Strategy, Emerging Markets) | At first glance newspaper headlines for the last 12 months would appear to make for uncomfortable reading for the emerging market (EM) investor. Headlines on the US-China trade war, sanctions, protests and talk of economic slowdowns are just some of the stories that have been making the front pages in 2019. Given this, one might think that emerging market debt has had difficult year, but it’s been quite the opposite. At the time of writing, the major EM hard currency indices have all returned more than 11% year to date. Even though the return and negative headlines might seem they are at odds, the reality is the attractive rates of interest on a big part of the EM debt universe is simply too good to give up in a world where investors increasingly have to pay for the privilege of holding debt, with some $17 trillion of investment grade bonds now bearing negative yields.
Will 2020 be different? On the fundamental side, very likely no. Global growth is still showing signs of slowdown and it is hard to imagine what could quickly turn it around. PMI data tracking manufacturing activity globally suggests we may be on the cusp of a slowdown. We have an increasing number of countries with PMI readings below 50, which indicates the sector is contracting, or in recession. We fear this could spread to the services sector as well.
How are we managing the risk of slower growth? We are planning to be strategically more defensive in our investment approach, favouring a diversified mix of countries and companies that can outperform in a more challenging landscape. In fact, our investment universe encompasses 83 countries. While many may be affected by a broader slowdown, all 83 of these countries are not moving in the same cycle and so many will prove resilient even if the largest economy in the world does move into a recession in 2020 or 2021.
To identify these countries, we focus on establishing their main drivers of growth. We favour countries that rely on local consumption rather than trade, given the current disrupted nature of global trade. We are also keeping an eye on central banks – there are several nations such as Brazil, Russia and India where rates are being cut and inflation remains under control, which should support growth.
With this in mind, countries we like in 2020 are actually those that often go under the radar. When one thinks of EM markets, the names that usually come up are those that represent the biggest weight in the benchmarks such as China, Russia, Mexico and so on. These markets are well researched, and it is more difficult to add value. As active managers, we believe we can add more value to smaller issuers which have very strong fundamentals. Of course, It’s important to note that when we say small, we do not mean illiquid. For example, Guatemala is often overlooked but it can boast political stability while the companies that are issuing debt here are often market leaders. Last year, when everything else was selling off, they outperformed the broader market. Another example is Kazakhstan, which we see as a play on Russia without the expensive spreads and heightened sanctions risk.
Of course, this isn’t to say that we are totally ignoring the larger opportunities. The right countries still have a place in our outlook, and we currently like Brazil, which has several pro-market structural reforms in the works in areas such as pensions and tax which we think should push growth. Importantly, Brazil also has a relatively closed economy driven by domestic consumption which suits our approach to minimizing trade risk.
Ultimately, the EM investment universe is diverse enough to survive the negative headlines even though it may not seem the case on face value. We remain cautious and try not to get distracted just by the carry. Instead, we focus on attractive fundamental stories which are worthwhile investing in even when the economic picture isn’t rosy. With this forecast in mind, we are looking away from the EM economies that are largely reliant on trade favouring instead smaller countries that have positive macro-economic stories, resilient domestic consumption, and where we can add value and get paid for the risk.