Further dispersions make the case for active management
“The covid-led economic disruptions which started in 2020 and are still present or resurfacing across the world, have not only widened the gap between developed and emerging markets but have also created further dispersions within emerging markets”, says Michael Wehrle, Head of Investment Solutions at BlueOrchard. “In our view, the dovish monetary policies witnessed over the past two years have flooded markets with liquidity and narrowed disparities. With such high levels of liquidity available, lenders were incentivised to support borrowers across the quality spectrum, thereby providing financing to weaker borrowers as well. In our view, this process tends to reduce the gap between borrowers’ varying credit profiles. Tapering, however, is likely to have the opposite effect as it will reduce the liquidity available in the system. As a result, we expect to see wider dispersions amongst issuers in the coming year which will materialise in various ways.
First and foremost, the pace of the vaccination program varies widely across emerging market countries. It goes without saying that the reopening of economies worldwide and the rebound that should occur as a result are highly contingent on the speed at which governments can inoculate their population. In addition, the volume of exports witnessed in 2021 have hugely benefited exporting countries and notably commodity exporters. Also, commodity exporters, such as Colombia, have been beneficiaries of stronger exports in that it was providing them access to USD at a time when the USD was strong. However, countries whose economic model is more service-oriented, such as countries that are heavily reliant on tourism, have suffered over the course of the past year. Those countries were adversely impacted as muted tourism activity weighed on their growth but also because they were left with limited access to USD. A separate issue is that some emerging market countries went into the covid crisis with weaker fundamentals than others and are already seeing their monetary and fiscal policies tighten although their economies haven’t fully recovered from the covid-led downturn. Finally, a heavy political agenda notably in Latin America will continue to be a driver of volatility and uncertainty in the coming months. We hence expect dispersions between emerging market countries to widen over the coming year. In such an environment, we believe having a selective approach and being active will be essential to generating alpha in 2022.”
Leveraged corporates most vulnerable to higher US rates
Florence Birkett, Portfolio Manager at BlueOrchard adds: “One of the key risks for emerging markets in 2022 will likely stem from the Fed’s tightening cycle. Funding costs will become more expensive for issuers financing a portion of their debt in US dollar. Countries and corporates with non-USD denominated debt are also likely to suffer as higher USD interest rates will push other rates across emerging markets higher.
It is however essential to emphasise that the current tightening cycle in the US is drastically different to the taper tantrum witnessed in 2013. The key reason is that most emerging market countries are going into this cycle with much stronger fundamentals than nearly a decade ago. That being said, corporates displaying high leverage levels and being highly reliant on wholesale funding will inevitably be the most vulnerable to higher interest rates. We hence believe that it will be crucial to focus on issuers with adequate leverage profiles over the coming year. In advanced economies, high yield-issuers are usually assigned a below investment-grade rating because of a high leverage profile. In emerging markets, however, we believe that is not necessarily the case. In our view, there are many reasons that can drive corporates to be assigned a high yield rating in emerging markets that is independent from their debt profile. For instance, a company with a solid credit profile but implemented in a country with a high yield rating will very often be constrained by its sovereign rating. A good example would be IHS Holding, a high yield-rated tower operator focused on numerous emerging markets. Despite its decent fundamentals, the company is constrained by the sovereign rating of Nigeria (B-).
In our view, emerging markets will offer attractive opportunities in 2022. Active portfolio managers will be able to invest in select high yield names whilst limiting exposures to the more levered issuers who are most at risk in a US rate tightening cycle. Finally, we believe that unlike portfolios heavily concentrated in few highly levered issuers, having a portfolio holding numerous bonds displaying idiosyncratic, uncorrelated risks will provide better diversification and more attractive risk-adjusted returns.”
Fixed Income reinstated as a diversifying tool
“During the Covid-crisis, most Central Banks across the world stepped in to support their economies and implemented accommodative monetary policies,“ says Evariste Verchere, Portfolio Manager and Head of Public Debt at BlueOrchard. “Those policies, as their goal intended, pushed yields on Fixed Income instruments lower. Over the past numerous decades, Fixed Income had been used as a diversifying tool in multi-asset portfolios. The rationale behind was that fixed income and equity instruments tended to be negatively correlated, i.e their prices usually moved in opposite directions. In 2020, however, the yield offered on fixed income instruments was so compressed already that Fixed Income struggled to play its diversifying role. In other words, the room left for bond yields to compress any further to offset a move downwards in equity prices was very limited. As of December 2021, however, we faced a drastically different environment with the Fed having started tapering its asset purchase program and markets pricing in several rate hikes for 2022. Initially, a move higher in yields will hurt bond prices. Duration management will notably be essential in order to protect fixed income portfolios. However, we believe that over the longer run, higher overall rates in fixed income will reinstate the asset class as a diversifier.
We are strongly convinced that the environment over the next twelve months or so will present numerous relative value opportunities for active portfolio managers. Investors will notably be incentivised to differentiate even further between issuers. The ability to invest in select names and to manage duration actively will be key in delivering solid, risk-adjusted returns in 2022.”
For further information, please contact:
Tahmina Theis
+41 44 441 55 50
tahmina.theis@blueorchard.com
Disclaimer
The information in this publication was produced by BlueOrchard Finance Ltd (“BOF”) to the best of its present knowledge and belief. However, all data and financial information provided is on an unaudited and “as is” basis. The opinions expressed in this publication are those of BOF and its employees and are subject to change at any time without notice. BOF provides no guarantee with regard to the accuracy and completeness of the content in this publication. BOF does not in any way ascertain that the statements concerning future developments will be correct. BOF does not under any circumstance accept liability for any losses or damages which may arise from making use of, or relying upon any information, content or opinion provided by BOF in this publication. This publication is provided for marketing reasons and is not to be seen as investment research. As such it is not prepared pursuant legal requirements established for the promotion of independent investment research nor subject to any prohibition on dealing ahead of the distribution of investment research. This publication may contain information, references or links to other publications and websites from external sources. BOF has not reviewed such other publications and websites. BOF in particular does neither guarantee that such information is complete, accurate and up-to-date nor is BOF responsible in any way in relation to the content of such publications and websites. The information in this publication is the sole property of BOF unless otherwise noted, and may not be reproduced in full or in part without the express prior written consent of BOF. All investments involve risk. We note specifically that past performance is not an indication of future results. Emerging markets impact investments involve a unique and substantial level of risk that is critical to understand before engaging in any prospective relationship with BOF and its various managed funds. Investments in emerging markets, particularly those involving foreign currencies, may present significant additional risk and in all cases the risks implicated in this disclaimer include the risk of loss of invested capital. To understand specific risks of an investment, please refer to the currently valid legal investment documentation. The materials provided in this publication are for informational purposes only and nothing in this publication can be construed as constituting any offer to purchase any product, or a recommendation/solicitation or other inducement to buy or sell any financial instrument of any kind and shall not under any circumstances be construed as absolving any reader of this publication of his/her responsibility for making an independent evaluation of the risks and potential rewards of any financial transaction. We note in particular that none of the investment products referred to in this publication constitute securities registered under the Securities Act of 1933 (of the United States of America) and BOF and its managed/advised funds are materially limited in their capacity to sell any financial products of any kind in the United States. No investment product referenced in this publication may be publicly offered for sale in the United States and nothing in this publication shall be construed under any circumstances as a solicitation of a US Person (as defined in applicable law/regulation) to purchase any BOF investment product. The information provided in this publication is intended for review and receipt only by those persons who are qualified (in accordance with applicable legal/regulatory definitions) in their respective place of residence and/or business to view it, and the information is not intended under any circumstances to be provided to any person who is not legally eligible to receive it. Any recipient of information from this publication who wishes to engage with BOF in furtherance of any transaction or any relationship whatsoever must consult his/her own tax, legal and investment professionals to determine whether such relationship and/or transaction is suitable. By no means is the information provided in this document aimed at persons who are residents of any country where the product mentioned herein is not registered or approved for sale or marketing or in which dissemination of such information is not permitted. Persons who are not qualified to obtain such publication are kindly requested to discard it or return it to the sender. BOF disclaims all liability for any direct or indirect damages and/or costs that may arise from the use of (whether such use is proper or improper), or access to, this publication (or the inability to access this publication). BOF has outsourced the provision of IT services (operation of data centers, data storage, etc.) to Schroders group companies in Switzerland and abroad. A sub-delegation to third parties including cloud-computing service providers is possible. The regulatory bodies and the audit company took notice of the outsourcing and the data protection and regulatory requirements are observed.
Copyright © 2022, BlueOrchard Finance Ltd. All rights reserved.