Is the emerging markets fixed income sphere rebounding?
The emerging markets fixed income sphere is recovering and we expect inflows back to the asset class after years of investor exodus. The combination of Fed tightening, China uncertainties and the war in Ukraine has been a perfect storm for emerging market debt and we anticipate a rebound across all sub-asset classes: FX; rates; EM sovereigns and corporates.
We believe that dollar strength is largely behind us as the Fed embarks on a rate cutting cycle. Consequently, EM currencies should recover. EM credit remains relatively cheap compared to developed markets, while the rates outlook appears benign as many EM central banks have either started or will follow the Fed in their easing cycles. We also see plenty of opportunities in the special situations space after years of dislocation.
What key factors are affecting flows into the area?
Inflows to the asset class should be supported by the Fed easing cycle, resilient fundamentals in EM versus DM, and US election risks subsiding towards the end of the year. Given the sound technical factors and the structural under-allocation to EM debt by large investors, we believe that inflows could be significant. For a sizeable and diverse asset class, EM debt is extremely under-owned.
Which regions are at the fore of the firm’s focus, why?
Asia is increasingly dominating the investment landscape, with a vast and diversified credit space, and India benchmark inclusion on the local currency debt side. We are finding some very interesting opportunities in special situations within Asia. There could also be some intriguing alpha opportunities in less liquid and under-researched frontier markets, across both hard and local currency markets.
How is your firm shifting strategies to maximise opportunities in the space?
In a general sense, the asset class has the capacity to provide high returns alongside diversification benefits. We believe it is a particularly good fit for active investors with a contrarian slant. EM investment styles and processes are becoming increasingly bifurcated between large passive or quasi-passive investors and very nimble ones that can exploit a volatile environment and sudden changes in flows or investor asset allocations.
Why are EM bonds set to be important for desks going forward?
While EM debt is likely to enjoy strong tailwinds overall, volatility is here to stay and having the right skillsets for each area will be key to success. Indeed, EM is a mosaic of sub-asset classes rather than a unified universe. It requires very different skills to trade EM FX versus rates or credits as the liquidity and price discovery mechanisms vary markedly. Desks that are designed to be nimble and opportunistic should be able to provide alpha through skilful execution.