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Four ways to protect EMD portfolios under Trump

BlueBay’s co-head of emerging market debt delves into the main issues surrounding developing world debt under a new US leader.

Trump's tenure and EM turbulence

With President-elect Donald Trump set to be inaugurated in less than 10 days, BlueBay’s co-head of emerging market debt, David Dowsett, who oversees several funds at the firm, including the BlueBay Emerging Market Bond fund, believes his presidency will have significant implications for emerging market fundamentals.

‘Trump’s victory is the most dramatic, but not isolated, example of the political backlash against well-established globalisation trends. We believe that many of the previous investment orthodoxies will no longer prove relevant or successful.’

‘We are facing an investment environment of more nationalism, more government interventionism, more active fiscal policy and the end of the QE experiment. In short, policy in the developed markets will now likely be much more squarely aimed at pleasing the domestic worker, rather than financial markets.’

In this gallery, Dowsett looks at key concerns and opportunities for investors in emerging market fixed income and what investors should be avoiding.

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1. Favour large economies

Dowsett said the next phase of emerging market growth needs to be driven from within and he believes large economies with a viable domestic consumption base should be favoured.

‘As income standards rise in EMs, consumers need to spend, and the services economy needs to develop. In this respect we like China, India, Brazil and Indonesia.’

‘We also favour commodity exporters. More active developed market fiscal policy and infrastructure initiatives can raise selective commodity demand. Beneficiaries include Russia, African commodity exporters and potentially high-yielding Latin American countries like Ecuador and Argentina.’

Dowsett said the team prefers to avoid small, open economies, which are reliant on cross-border capital flows to fund financing requirements.

‘For us this would be countries such as Mexico and Central America, we would also be cautious on North Asia ex- China, Central Europe and Turkey.’

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2. Reduce duration and increase yield

Dowsett expects rising US treasury yields to create a consistent performance headwind for long-duration assets. ‘A preference for high-quality, long-duration and relatively low-yielding assets has been a winning formula for EM portfolios over most of the past five years. In our view this trade is now over.’

However, Dowsett said stronger growth and higher commodity prices could improve emerging market credit worthiness. ‘We see a sweet-spot in EM credit in high-yielding, short-duration assets. In local markets, high carry assets are also likely to do well.’

‘Interest rate cycles in EM are not synchronised with the developed world. We expect interest rate cuts in 2017 in Brazil, Colombia and Argentina. Meanwhile stronger growth should help the relative performance of EMFX (emerging market foreign exchange).’

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3. Alpha, not beta

Dowsett said the team are expecting the world to become more nationalised and less globalised, He said, as global capital flows slow, policy settings and individual market performance are set to diverge.

‘Global QE made individual EM central bank policy decisions somewhat irrelevant. We believe this will now change, as there will simply be less capital available to suppress volatility and ‘arbitrage’ individual country yield curves.’

‘Additionally the more uncertain geopolitical world described above will raise single-country political volatility. All of this suggests return correlations within the asset class will fall.’

The decision of where to invest will become far more important than the decision of when to invest, added Dowsett.

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4. Prepare for raised tracking error

Dowsett expects a more uncertain, less efficient world and said this environment could be rewarding for active investors. ‘Investing on an indiscriminate, diversified fashion with high sensitivity to long duration indices has actually been a relatively successful way of accessing the asset class since 2008.’

‘We believe this will no longer be the case. Higher conviction, more concentrated and shorter duration portfolios are those which we think offer the best risk/reward,' said Dowsett, who added these will look less like the index and adopt a significantly higher tracking error.

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David Dowsett
David Dowsett
111/147 in Bonds - Emerging Markets Global Hard Currency (Performance over 3 years) Average Total Return: 5.70%
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