Ask The Expert: What is the outlook for EMD?
Our latest special report: 'Emerging Markets Debt Outlook' features an Ask the Expert interview with Bradford Godfrey, Institutional Portfolio Manager at Eaton Vance.
Sebastian: What is Eaton Vance’s history and approach to investing in emerging-market debt (EMD)?
Brad: We manage EMD across the full spectrum of the asset class, which includes local currency sovereign, hard currency sovereign and corporate credit. As a team, we’ve been investing in EMD for about 25 years in a number of different capacities. We started managing EMD through a long-short approach back in 1996, which is perhaps a little unique in this industry. We then launched EMD strategies in local currency sovereign in 2007, blended EMD in 2013, hard currency sovereign in 2015 and corporate debt in 2018.
In many ways, we built our EMD business in reverse. Most asset managers would likely start with hard currency, then try a blend, then dedicated local currency, and then perhaps, if successful, they would adopt a long-short approach. Starting with the long-short approach, one starts with the risk side of the equation as well as deep, individual country research, which is inherent when you’re trying to produce an absolute return for clients. Furthermore, it has broadened our investment universe as we have sought more idiosyncratic country risks.
We believe that one of our key advantages is the breadth of our investment universe. We analyse about 115 emerging-market countries, and we’re not aware of any other EMD team that has a broader universe. The wide universe is of central importance for us, as it allows us to uncover additional opportunities that others may not even be evaluating. A wider universe also adds additional diversification to our portfolios and for clients.
Our approach to research focuses on a deep understanding of the direction of policy within countries. We’ve observed that many of our industry peers, in contrast, are more focused on economic outcomes rather than the policies that drive them. We look for countries moving in the direction of embracing free-market policies, such as limiting size of government and regulation, sound money, respect for property rights, and a strong rule of law, among others.
In our view, better policies lead, by and large, to better economic outcomes. That explains our focus on the direction of policy, which is ultimately the determinant of asset price movements. Our 40-person EMD team enables us to conduct in-depth country research. While we visit 60-80 countries per year in normal times, we have adapted well to the new environment in moving to virtual “visits” with in-country policymakers, corporate managers and other on-the-ground specialists.
We also seek to add value through our dedicated trading desk’s unparalleled ability to access markets, which we refer to broadly as our “operational alpha.” Market access isn’t something that a team can start with immediately. We have built our trading and operational infrastructure over the course of the past 25 years that we’ve been investing in EMD. As one may be aware, the operational challenges in the EMD market are many, particularly on the local-currency side. There are trading challenges as well. In some cases, even the largest EMD investors can’t resolve these challenges, as they lack the level of market access that we have.
SCS: How is the asset class faring in the current environment, and what changes have you seen over the course of this year?
BG: It has been an interesting 2020, to say the least, as we all seek to deal with the human loss and ongoing challenges that the COVID-19 virus has and continues to create for all, both personally and professionally. Further, when speaking of emerging markets countries we are talking about the lives and livelihoods of some of the world’s most vulnerable people and we never lose sight of that.
As for markets, we were somewhat cautious at the start of the year. Because we analyse countries all around the world, we had some insight into the potential adverse effects of the coronavirus, as we witnessed the spread through Asia. We couldn’t foresee exactly how it would pan out, obviously, but we became concerned early on and that led us to start peeling back exposures to places that we thought were potentially vulnerable.
The coronavirus is without a doubt the story of 2020. In March, when it was widely recognised for what it was – a global pandemic – financial markets saw remarkable declines, and EMD was certainly no different. While it may seem like a distant memory now, at the time the EMD asset class faced another risk as a result of the Saudi-Russian oil price war, which created a dual shock for many oil-exporting countries.
These shocks created exceptional challenges for emerging markets, because, by definition, they’re more vulnerable economically. Many workers participate in the informal economy and are unable to work remotely in order to continue earning a paycheck. Social distancing is also challenging, and many emerging market countries lack the healthcare infrastructure and resources needed to respond adequately to COVID-19.
The one silver lining is that these economies, broadly, did not contract as much as might have been feared. And, in certain circumstances, have bounced back better than expected. Although it is bad in absolute terms, it is perhaps slightly better than expected and the direction is an improving one. As we all know, markets trade better and worse, not good or bad, so to some extent that helps.
Beyond that, the massive policy responses from governments and central banks around the world have been astounding. They have been quick in implementing these policies, and from our perspective, as we look forward that support will be very slow to recede.
Also, valuations are fairly compelling in emerging markets and we have seen yields across the developed world reduce towards zero and below, which we think leaves a lot of investors looking to emerging markets for yield – a key driver behind the rebound.
The article continues in the latest special report: 'Emerging Markets Debt Outlook'