Emerging markets debt strategy

Gaining from greater
EM dispersion

mar 10, 2017
por Pablo Goldberg , Sergio Trigo Paz

Highlights

  • A political and policy transition in several developed markets (DM), to more populist and protectionist policies, affects emerging market countries differently. We expect dispersion of emerging market debt (EMD) returns to increase as a result, making country selection and duration management key to avoiding volatility and drawdowns.
  • We see EMD as uniquely positioned to receive global investment flows out of lower-yielding fixed income assets that could generate negative returns due to monetary policy normalization. EMD spreads help serve as a buffer to eventually higher DM rates.
  • History shows EMD can perform well in a reflationary world as long as its fundamentals are strong. EM growth is accelerating, and we expect more improvements to come this year amid an apparent stabilization in China’s economic growth trajectory and robust commodity price gains.
  • In efforts to achieve income stability this year, we favor high-yielding commodity producers versus low-yield manufacturing exporters and avoid investments that have binary outcomes. We believe unconstrained total return strategies are very well suited for capturing these opportunities.

Outlook and strategy

We break down U.S. President Donald Trump’s proposed policies into key drivers of EMD performance, and conclude that investors should consider having: a short-duration bias, an emphasis on relative value and dynamic management of currency exposures. The good news is that EMD is a diverse asset class, and that current policy and political trends in DM are pointing toward greater dispersion. The DM transitions will likely provide twists and turns that demand active management of both exposures and hedges. A potential trade war and the French elections are risks to monitor, while inflows into EMD could compress valuations further.

A bit more than three months have passed since the U.S. presidential elections and the scenario we have put forward in our EMD 2017 Outlook has been playing out to a large extent. Global monetary stimuli are slowly being rolled over and the U.S. administration is discussing domestic fiscal expansion. Duration headwinds remain a risk to fixed income assets as the global economy reflates, and developed markets, led by the U.S., are showing a protectionist bias that could hurt EM.

We see EMD outperforming other fixed income markets in 2017. A return to trend global growth is positive for emerging markets, in our view, while EM spreads can accommodate the duration drag. EMD has had a strong start this year, with hard-currency spreads now tighter than before the U.S. election. We believe improvements in fundamentals justify the compression. Further, EM growth is accelerating into 2017, led by exports and industrial production, and oil prices are supported by strong OPEC production cut compliance. Importantly, China growth remains stable.

Pablo Goldberg
Managing Director, Portfolio Manager and Senior Strategist for BlackRock's Emerging Market Debt Team
Sergio Trigo Paz
Managing Director, is Head of BlackRock’s Emerging Markets Debt Team