Opportunities in Emerging Markets Debt

OLGA HAY: Hello and welcome to Asset TV Masterclass on emerging markets debt with me, Olga Hay. Emerging markets have been historically associated with high yields and higher risks. Does the common perception reflect the reality? To discuss this, I'm joined today by Abdelak Adjriou, Vice President, Portfolio Manager, American Century Investments. Well let's just start from the very beginning---is it true, you know, how volatile in reality are emerging markets?

ABDELAK: I think that the universe is pretty large so you can find safe haven asset even in Yemen and very risky assets. So, it's so large that the universe goes from Argentina, which is very risky, and you can go to Hungary, Poland or Paraguay, which are safe for us.

OLGA: So that reputation that they're much more volatile is actually true. I mean, you do have much more volatility in emerging markets, do you?

ABDELAK: Compared, depends—compared to what? Compared to Treasuries? Yes, compared to USA? Not necessarily. As a nation, what's the most important is the way you move your portfolio. So especially in our approach, where we have a total return approach, we can make a portfolio with combining safe, even asset in EM and risk on asset to have a more balanced portfolio.

OLGA: What are you making in terms of the stories that's happening in China, for instance, right now, you know, how affected were they from this trade war and other countries as well? You know all the other countries that are benefiting from that story?

ABDELAK: I would say the common characteristic where you see the impact of the trade tension is global trade slowdown. That's definitely the case for the most open economies, like Korea, like Taiwan, like Chile, you see the export falling and so does currency.

The countries that benefited from the trade tension, there are a few. Some Asian countries. So, for example, The Philippines benefited, Malaysia, Indonesia and in Latin [America], Mexico. You see that their currency has actually behaved in a better way than these open economies that I've mentioned.

OLGA: Is it a problem for you? The inflation in emerging markets? How you counting this into your process?

ABDELAK: Of course, it's inevitable that we take it into account. But the other moment what we have seen for the last even two years is that the inflation has decelerated in almost all emerging market countries, except the one where we have seen political problem like Turkey and Argentina.

But even Turkey this year, inflation has slowed down a lot. If you look at South Africa now, inflation is very low. Brazil, inflation is very low. Indonesia, inflation is rare. So almost across all the boards, you see no inflation as in EM countries.

OLGA: So as fixed income investors, you know, how are you benefiting from this?

ABDELAK: Yeah, rates are going down. And so buying local government bonds is very positive for your portfolio.

OLGA: But there is also another perception about emerging markets is that it's very hard to get reliable data, whether that's about governments or corporate, especially probably, in this universe. You know, how reliable is the data that you get. How much do you question it?

ABDULAK: Most of the countries have readable data. The few that don't have we tend to exclude them from our process.

OLGA: You know, another perception I think about the emerging markets is that you should, when talking about the ESG factors, you would meet the same standards as probably on the developed markets, and you should naturally lower your expectations and give them a bit more leeway. And Abdelak, from your point of view, you know, ticking those ESG boxes is more of an exclusion process and are you ultimately limiting your returns if you're looking, if you have to meet those ESG requirements?

ABDELAK: I disagree with that. What we have found is that usually good governance that's to provide sustainable return in the long term. And I would say as well that ESG in our EMD at American Century Investment, we are privately owned by a medical research center. Today, the EMD team is fully ESG integrated. And so, it's a very important factor for us in our investment process.

OLGA: But by eliminating some of those companies that may not have a great ESG score oil and gas companies or tobacco companies, I don't know, But ultimately they're delivering great returns. Aren't you sort of compromising on the returns there?

ABDELAK: We found alternative solution to make returns. We think that--- So we have our own ESG rating. So, that would drive our decision to take a position on a company.

And ESG as a dimension: If you have a bad governance, it tends to have negative long term returns. So we made that…and so it goes with so ESG is not compatible ways. Having good returns, you can have both. You can have ESG and good returns.

OLGA: Well, let's have a look at this year, 2019, and how has it been for the emerging markets debt? And after that, What about you? You know, those double digit returns? Driving them from a debt market is like basically, they're giving you the equities returns in the in the debt market. You know, you shouldn't be. I mean, obviously, there are some challenges that you're facing along the way. It's obviously not that easy, I think.

ABDELAK: I used to say that the EMD is a fixing income class giving equity returns, but the risk is a fixed income class, so you have fixed income risk and the equity returns. This year, actually, the double digit return was not driven by EM factors, it's more US duration that has driven the double digit returns.

So, I'm not surprised because US rates dropped 120 this year. Yeah, and so local assets, actually that have a currency component, when you look, the currency component is a detractor, but the rates component has been very positive. And the same for XL Spread has been benign, but the duration has been a strong factor.

OLGA: Abdelak, let's have a look at the US Dollar. You know, how have you benefited from the way the US dollar has been going? And what's your outlook for it?

ABDELAK: So I will start with the outlook. We think that the dollar has topped out, but it doesn't mean necessarily that we are going to enter in the bear trade. So you have to be selective and currencies. We think that if you're in a currencies with high carry you should have positive return at a one year forecast. Why we think the dollar has stopped out. It's because the first component that explained the dollar move is the gross differential dynamic between EM and DM and we see that the cross differential will be in favor of EM next year.

OLGA: Interesting fact, though, have investors learned their lessons because straight off to almost the markets fell, investors rushed back to buy the debt of the major discount. Yes, but even...

ABDELAK: Even a teachable price, because we think they are going to default. The level of recovery is very difficult to assess at the moment. So they're sensitive around it. Pushing us not to have any position in Argentina today. It's not clear what new President Fernández is going to do, so we prefer to stay out.

OLGA: What are you making off the possible scenarios and how they can evolve in the US Presidential elections? How potentially can affect which countries other than public China to be most affected.

ABDELAK: Yeah, so I think that whoever wins Democrats or Republicans in US want to change the policy with China.

OLGA: They won't change it?

ABDELAK: No. I think it's, ah, this policy to reduce the influence of China, to change China, at least for a policy. It's a US policy, it's not Democrat or Republican. I actually think--we actually think that Trump would be better for China than the Democrats.

OLGA: What about Bloomberg? He's quite friendly to China.

ABDELAK: Yeah, it's a possibility as well that you can win the, it could be the Democrat candidate, but so far what we see. Joe Biden has a good chance as well to be the Democrat candidate.

OLGA: In terms of country's top three positions. What are the countries that you like?

ABDELAK: We also like Egypt. Great, very fast all the numbers improving, inflation, current account. We like Russia, especially on the local side. Next somebody's It's already very tight on the last one that we really like, It's a little bit from prying, but we like Turkey, external and local, both the currency, despite being down 8% year to date but total returns to carry you have 13%. So it's one of the best performer. Rates as well. Local rates have dropped significantly because of the innovation style that way talked at the beginning and finally we like a sow external. We think that the problem is too high compared to the fundamentals, tricky experience or recession, but now we see that Turkey is bottoming out across is accelerating on the current I could, despite cross accelerating it's still neutral or slightly positive for Turkey, which is a very young country. It's to have a current account of that level. It's very positive.

OLGA: What other countries would you advise to avoid and you're avoiding yourself?

ABDELAK: Today, we would advise to avoid Colombia, for example. It's more from a macro perspective. It's not necessary from a political perspective, because this, I mean, the numbers are deteriorating, current account, the fiscal as well. The fiscal numbers are very bad. So yeah, we will advise to avoid Colombia. RG obviously we don't have it. Um, acquirer way. We like it, actually, despite the protest, because we think that there is the wheel to do the reforms and to pay back to that, I think the government is very different from the previous government. Yes, that's the main countries that we don't like.

OLGA: Abdelak, you're running a total return fund. How does it work in this universe?

ABDELAK: So, we advise to investing in total strategy because for three reasons.

First, because we decide the level of risk that we want in the portfolio. Second reason is because we choose the allocation between local and external. There is no preset location. If we like more external, we can go 80% of the fund in external and no local exposure. If we like local, we can go to local exposures. There is no preset locations. And the third argument for having a total return strategy is the downside protection. It's true that the volatility has been low, but, it's always the case when things okay. But when things turn, volatility can jump very quickly. And so the total return approach could be a solution to avoid this period off high S&P and high volatility.

OLGA: And also in emerging markets, when you're you know, allocating to emerging markets in your portfolio, you're picking up currency risks. So is that something you should be considering?

ABDELAK: Yeah, we think that currency is not necessarily a risk, but it could be an opportunity. When you look this year, ruble is ready 10%. If you include the carry, it's 16% year-to-date it's good return. Turkey, sure as well, as a nation, up 12%, including the carry.

You know, you need to understand how the currency works. And the currency is the adjustment mechanism of the balance of payment. So if you follow a process where you see balance of payment improvement, you should buy the currency. And we treat currency like another asset. So far, it has been a positive contributor to our performance.

OLGA: On our last question, looking forward to 2020, what are the main, probably, challenges and risks that investors should bear in mind going forward in emerging markets, that universe.

ABDELAK: We expect a single digit return this year because first, we won't have the headwind that the duration contributed this year. But so we think that he would be more carry story for next year, despite we think that the global gross should pick up next year with the oldest distributors that central banks have been doing and as well because we believe in cycle and the slowdown in cycle that started in 2018.

Beginning of 2018, we should see some pickup, maybe to 2020 and through 2020 for global growth. So that's positive for EM. That's why we expect single digit return in 2020 for the year.

OLGA: Well, thank you very much. Unfortunately, that's all we have time for now. But let me remind you, we've had Abdelak Adjriou, Vice President, Portfolio Manager, American Century Investments. Thank you very much for coming today. That's all for now. Bye.