Understand emerging markets opportunities and the American Century advantage.
By Margé Karner - September 2019
The return potential of developing economies is a given. But, the ability to capture it without undue risk is not.
Our investment team navigates the complexities of these fast-moving markets by dynamically shifting between the different sub-asset classes and countries to take advantage of market opportunities. This flexibility is an important lever in helping to manage risk and drawdowns, but also capture upside.
Discover how our actively managed, unconstrained solution may help you get the benefits of an EM debt allocation.
Listen to the podcast.
VACHALEK: Thanks for clicking on this podcast! I'm Lisa Vachalek at American Century Investments, and I'm here today with Margé Karner, senior portfolio manager for American Century's emerging market debt strategies.
VACHALEK: So, Margé, if you could start off by telling me what is the role of emerging markets debt in an overall portfolio?
Margé: Emerging market debt offers very attractive yield in a low yield environment, as well as long term attractive risk-adjusted returns. In addition to that, emerging market debt can be an important diversifier in investors asset allocation.
VACHALEK: Why to investors hesitate to include emerging markets debt in their portfolio?
KARNER: In my experience, often investors have a perception that emerging market debt is very risky. However, in reality, it is often not the case. That also depends on what part of the universe you have exposure to, and under what market conditions.
Overall, emerging market debt is actually a very high-quality investment universe. Many investors are surprised to find out the emerging market debt corporate index, for example, is investment grade rated. Most companies in the index are investment grade.
VACHALEK: There have been a lot of headlines recently about the trade wars and central bank policies. How does that affect investors when they're considering emerging market debt for their portfolio?
KARNER: Because emerging market debt universe is very diverse and large, there are often headlines about political risk as well as other geopolitical developments that affect these countries that raise concerns for investors. while trade tensions will have negative impact on global growth overall, different countries including countries within emerging markets will be effective to different degrees, depending on their dependence on exports and their range of trading partners.
There are a number of large emerging economies that are domestically focused and less dependent on trade, such as, for example, Brazil. In addition to that, different emerging countries have different trading partners. The only country very highly dependent on the trade with the U.S. is Mexico, with exports to the U.S. accounting for about 30% of GDP, which is very high. However, you can see that outside of Latin America, other emerging market countries don't really have much exposure to trade with the U.S.
VACHALEK: Because all emerging countries tend to get painted with the same brush, they are considered the same thing. When you talk about emerging markets debt and emerging markets equities together in a portfolio, some people are hesitant—that that's too much emerging markets exposure. Why is that not the case?
KARNER: Many investors are surprised that EM debt and equity universes are actually very, very different in terms of the countries you get exposure to.
The reason for that is that the constituents for the debt and equity universe are actually very, very different. For example, close to 70% of the EM equity index is in Asian countries. EM debt universe is much more equally distributed with about a third in Asia and a third in Latin America and a third in Europe/Middle East region.
By adding EM debt to your EM equity exposure, you actually get a much broader and more diversified exposure to emerging markets as a whole.
VACHALEK: Margé, in your opinion, what is the best way to add emerging market debt exposure?
In our view, the best way to get exposure to emerging market debt is through an unconstrained approach. It's a very large and diverse investment universe with a whole range of opportunities in terms of country exposure, as well as different instruments and sub-asset classes such as U.S. dollar denominated sovereign and corporate debt and local currency bonds and EM FX.
Dynamically moving between the different sub-asset classes within the emerging market universe, is an important lever in managing risk as well as capturing upside, depending on what market environment we are in.
VACHALEK: You specifically bring up this ability to dynamically move. So why is that such a boon for active managers versus an index?
KARNER: Active management is extremely important in emerging market debt. The universe is very diverse, and the different countries as well as the different instruments and sub-asset classes within this universe are driven by very different economic drivers. And therefore, they will behave differently in different market environments. Given how rapidly changing the EM debt universe is, we need to really be flexible to use risk models actively.
The emerging market indices don't capture that opportunity set very well because just by definition, the indices often have biggest exposures to countries with the largest amount of debt, which is not always what you want to have biggest exposure to in your portfolio. There are significant concentration risks, particularly in the local currency index
VACHALEK: How do you go about managing volatility in this asset class?
KARNER: One of the main concerns that many investors raise about emerging market debt is the potential volatility. In our view, having an unconstrained approach actually offers many levers to manage that volatility and deliver attractive risk-adjusted returns with lower volatility.
There are three main levers for managing volatility in an unconstrained EMD portfolio, which are beta, tactical allocation, and then very rigorous stress testing framework.
The beta in the portfolio is really driven by the top down views of growth and rates outlook. For external and local allocation, we add the dollar view and evaluation of each sub-asset classed to that. In addition to that, the bottom of security selection is a very important alpha driver, so that within each sub universe, so within, we've picked the best opportunities. What brings it all together at the end is a very rigorous risk management framework.
What happens if the U.S. yields go to 3% or oil falls to 4% and so forth? Then we have to decide, of course, based on our judgment, what scenario are we in? What is the scenario we're concerned about right now? Last year the scenario everybody was concerned about was the U.S. yields going to above 3%. Then we can see, based on historical data, how our portfolio would've behaved under that scenario. Then we compare it to the emerging market debt universe and calibrate our risk positioning accordingly.
In today's world of low developed market yields, emerging market debt offers attractive yield with a better credit quality than higher-yielding developed market credit.
VACHALEK: Thank you so much Margé for your time today. For additional insights from our portfolio managers and more, check out the American Century podcasts on iTunes, Stitcher or where ever you find your podcasts.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
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