As he reflects on events in 2014 and looks forward to the coming months, Peter Eerdmans, Co-Head of Emerging Market Fixed Income at Investec AM, sees more room for positive EMD returns this year.
How did EMD perform in 2014?
2014 was an eventful year for emerging markets, characterised by geopolitical risk and volatility. 2014 was, however, better than 2013, when there was a lot of negativity about emerging markets. Since then people have started to re-engage with emerging markets. They rallied through the spring and summer, but when the dollar started strengthening the markets ran into resistance again. Nevertheless, emerging market bonds have continued to post positive returns on the year, as many emerging markets have reached a level of economic maturity that allows them to benefit from low global inflation. EM currencies have been more mixed, as some economies require further adjustment to cope with tightening US monetary policy. Also, geopolitics has had a major impact on specific countries, notably the Russia/Ukraine conflict, the Argentinian default, and Iraq/ISIS. These themes have impacted local markets but not global emerging markets as a whole, allowing currency selection between countries to offer some protection to investors.
Should we be concerned about rising interest rates and a stronger dollar in the emerging economies in 2015?
The markets will have to work with rising interest rates from here and with that probably a slightly stronger dollar. We will have to navigate the portfolios through those times. But we do not think that there will be either excessive interest rate rises in the US or excessive dollar strength. The US also has its issues. Trend growth is lower, which means we are unlikely to see a strong US dollar bull market, as in the 1980s and the late 1990s.
The asset class has re-priced: we think emerging markets are a lot cheaper and a lot more is priced in. Emerging markets have implemented reforms and now have flexible exchange rates, their current accounts look better, external debt is lower, and FX reserves are healthier. To re-cap, many key factors in emerging markets are stronger today than in previous crises, so we think emerging markets will perform better in future crises. Of course, there will be times when we have to adjust the portfolio more tactically to protect it, but there will be other times when emerging markets will perform well.
What are the biggest risks to these views?
One of the key risks is monetary policy withdrawal, i.e. less easing and more tightening over the next year or so. But as outlined above, we think that emerging markets are well placed for that. We also think that they will react with more positive reforms. Emerging markets have had an easy decade. Quantitative easing made it very easy, as a lot of money flowed into emerging markets.
Another risk is China. A key question is: Will we see a hard landing that will impact Asian markets and commodity prices further? We think that the Chinese have all the levers to navigate their growth gently slower as they rebalance their economy. Notwithstanding this, we believe there is going to be a moderate slowdown in China, which we think emerging markets will be able to withstand. There will be winners and losers from slower growth in China — countries such as Turkey and India which compete with China for commodity imports will benefit as the price of those commodities fall.
How are you positioning your different strategies?
We run a lot of different strategies. Broadly speaking, we prefer markets that are weighted towards manufacturing. Asia is a region that we like, especially as regards to currencies. We are more cautious about rates. Latin America will be slightly more challenging, in terms of growth, because of the predominance of commodities in that region. Overall, we like bonds better than currencies because our inflation outlook sees moderating inflation and lower inflation should help bonds. We are more neutral on currencies, as although they offer value they are faced with a dollar headwind. We focus on relative plays, on picking the right countries to be overweight and picking the right countries to avoid.