16 May 2023
Emerging market debt can be dogged by misperceptions. But EMD has shown relative resilience in a tough environment, and EMD portfolios can be customized to meet a range of distinct requirements for insurers.
Portfolio Manager, Emerging Market Debt Team
We recently met with Elisabeth Colleran, emerging market debt portfolio manager at Loomis Sayles. Elisabeth is experienced in managing emerging market debt portfolios customized to meet insurers' distinct requirements across a number of jurisdictions and regulatory regimes. Read on for her insightful comments.
1) Capital markets were tumultuous in 2022. How did emerging market debt fare?
We did not see an overreaction in emerging market (EM) corporate spreads despite what I call "the old playbook" of Federal Reserve hikes leading to an EM selloff. That said, duration played a role in some of the dispersion across fixed income asset classes, and within EM.
Overall, EM corporates were resilient compared to other fixed income sectors in 2022. This was despite two significant EM-centered events—Russia's invasion of Ukraine and China's zero-COVID policy. Looking at the EM hard currency corporate space where we largely invest, EM investment grade (IG) and high yield (HY) corporate spreads widened less than those of US IG and HY. When comparing 2022 calendar year total returns, EM IG and HY corporates outperformed their US counterparts (chart below). On the flip-side, EM sovereign IG, with very long duration, modestly beat out EM equities as the worst performer across major asset classes. But surprisingly, EM local currency ended the year in the middle of the pack despite the strong dollar.
2) You have long favored EM corporates versus sovereigns. Has that thesis changed as we have entered a new regime of higher yields and higher inflation?
No, my view on the benefits of EM corporates versus EM sovereigns hasn't changed.
EM corporates have consistently offered a spread premium to sovereigns and US corporates on a ratings and duration-adjusted basis (chart below). Given the persistent premium, we believe the value proposition within EM resides within the corporate space. The EM corporate debt sector offers a history of strong risk-adjusted returns, a large and geographically diverse buyer base and solid stand-alone credit metrics. We think these characteristics align well with insurance companies' desire for diversification through stable and higher yields.
In terms of the regime of higher yields and higher inflation disproportionately impacting EM, the playbook may need to be edited again. This cycle, EM central banks were ahead of the Fed and other major central banks. They acted early and swiftly to try to combat rising inflation as opposed to reacting to steps taken by the Fed. As a result, it is our opinion many EM Central Banks will likely have policy room to prioritize growth objectives as we see inflation roll over.
On a micro level, over time EM company management teams have grown accustomed to dealing with inflationary environments and have built credibility managing through them. A year like 2022 highlighted this skill and the resulting defensive nature of EM corporate bonds. Over the long term, emerging market corporate net leverage has remained consistently below that of developed market (DM) corporates (chart below). It is our experience that these sound characteristics combined with deep credit research can reveal attractive real-yield potential opportunities. Insurance companies are well suited to harvest the spread premium that this sector offers given their longer investment horizon and natural ability to withstand spread volatility.
3) What is your growth outlook for EM?
We don't expect a significant EM growth slowdown or meaningful ramifications from potential future rate hikes by the European Central Bank or the Fed. As I mentioned, EM central banks now are in the position of being able to cut rates to help foster growth if decelerating inflation trends continue.
We do expect EM economies to benefit from China's spending rebound, which was unleashed after the country reversed its zero-COVID policy. In addition, we are seeing evidence of core EM countries deriving growth from internal improvements in consumption, investment and government reforms. We believe these favorable developments should help insulate EM countries from the vagaries of volatility and slow growth in DM.
4) How do you deliver EM corporate portfolios to insurance investors?
We work closely with our experienced insurance solutions team to map out and meet the unique requirements of our insurance prospects and clients. Beyond customizing portfolios around quality, duration and ESG considerations, we have had demonstrated success leveraging our fully integrated technology and trading platforms to hedge all currency exposures using cross currency swaps. We work to ensure insurance-specific considerations (regulatory regime, gain/loss sensitivity and income focus) are reflected in mandate objectives.
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