Examining Emerging Market Debt

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This is Richard Lawrence. I’m a senior vice-president on the global fixed income team at Brandywine Global Investment Management in Philadelphia.

On the topic of emerging market debt, we actually still like the positions that we own in the EMD [emerging market debt] countries that we’re exposed to. Coming into this year, I would say we came into the year thinking that, overall, we were looking at an environment with diminished macro risk for emerging market economies. We had the U.S.-China trade deal. We had a very supportive monetary policy framework in place around the world, and we liked the look of emerging market bonds coming into the year. And, in fact, in the first couple of months of the year, we just saw a steady decline in yields in emerging market bonds around the world. As Treasury yields fell in the U.S., so did MBONO yields fall in Mexico, and so did Indonesian yields fall and Brazilian yields fell. But similar to a lot of other risk markets, that middle two weeks of March created carnage — very temporarily — in emerging market bonds.

So over the course of about nine to 10 days, we saw yields explode wider in Mexico, in Colombia, in Indonesia. I’ll give you an example: so Mexican 10-year MBONO yields, they came into the year at 6.9%. And at the peak of the crisis, they’d blown out to 8.3%. But you know where they are as of the middle of May? They’re at 6.1%. So they’re actually lower than they were at the start of the year. It just tells you that once you got through that very, very risky period in the middle of March, the underlying macro fundamentals in emerging markets still look intact to us. And that’s a story that’s played out in Colombia, in Indonesia, in our positions in South Africa, in Brazilian bonds.

We have not increased our exposure to emerging market debt. It’s not that we don’t like the opportunities there. We’ve just got the portfolios balanced right now, with another very interesting opportunity in investment-grade credit in the U.S. With the Fed stepping in and being willing to backstop investment-grade corporate credit in the U.S., we’ve seen a lot of high-quality issuers come to market. We have been participating in a number of deals in the primary market, and we’ve added a lot of very attractively priced, high-quality U.S. investment-grade names to the portfolio. So, that creates a nice diversifying risk to the emerging market debt exposures that we still have and still like in the portfolio.

The one thing we’re watching carefully though on the emerging market bonds is they’re a little bit later in terms of their COVID-19 outbreaks in terms of timing. We’d like to think of this as having taken place in three waves. Wave one being in North Asia, wave two in Europe and North America, and now wave three in emerging markets. So we’re watching a couple of hotspot countries. The [Covid-19] numbers in Brazil and Russia, for example, have been catching our eye here in the middle of May. But so far, we haven’t seen anything that gives us a significant level of concern
On the corporate credit question, in terms of sort of where we’re taking the exposures. Well, we’re trying to stay away from areas such as energy, which of course, have been very stressed with the performance of oil prices recently. And instead, we’ve tended to favour names in technology, the industrial sector and the consumer sectors. So I’ll reel off a few names and you’ll quickly get a sense of just how high-quality some of these exposures are, but it’s names like Disney and UPS and Intel and Coca-Cola and Wells Fargo and McDonald’s. And all of these names are really high-quality names, strong balance sheets, solid free cash flows, all in the triple B to A, to A-plus tier. But they all came to market at significantly wide spreads. And some of the bonds that we own here in the middle of May are up 30 to 40 points from where we bought them. And we still think there’s the opportunity for further spread compression from here.