Emerging Markets Bonds – Argentina Rejoins Index and Boosts Yield
In a somewhat accelerated fashion, Argentina recently became eligible for inclusion in the J.P. Morgan suite of GBI-EM indices. This follows a series of measures that have been implemented to facilitate foreign investor access to local government bond and currency markets. As a result, several Argentine peso-(ARS) denominated bonds were added to the J.P. Morgan suite of GBI-EM indices on February 28. The eye-popping aspect of the ARS bonds is their high yields, which are yield between 13.4% and 14.4% as of February 28. Argentina now represents approximately 3% of the GBI-EM Global Core Index (GBIEMCOR), and the net effect of its addition was more than 20 basis point boost in the overall yield of the Index to 6.75%.
Argentina Debt Boasts Substantial Yields
10-Year Local Currency Sovereign Bond Yields (%) As of 2/28/2017
Source: FactSet as of 2/28/2017. All performance quoted represents past performance. Past performance is no guarantee of future results.
Argentina’s Low Correlation May Provide Portfolio Diversification
A more interesting aspect of the ARS inclusion may be the effect of the political and economic dynamics of Argentina on the country’s foreign exchange rate. In short, since the ARS was liberalized at the end of 2015, it has exhibited an extremely low correlation to the J.P. Morgan GBI-EM Global Core Index coming in at 0.07 for the 14 months ending February 28, 2017 – making it an attractive from a diversification standpoint. It is likely, however, that by its very inclusion in the GBI-EM indices, the consequential impact on flows may increase the ARS correlation. However other currencies which are excluded from the tradeable and most benchmarked indices, such as the Indian rupee (INR) and the Chinese yuan (CNY), have shown much higher correlations than the ARS, as shown below (0.54 and 0.52 versus the GBI-EM Global Core Index).
We expect that Argentina’s net effect on the J.P. Morgan investable benchmarks to be, as a consequence, both additional yield and greater diversification.
Currency Correlations
January 1, 2016 – February 28, 2017
ARS – Argentine peso, BRL – Brazilian real, MXN – Mexican peso, RUB – Russian ruble, PLN – Polish zloty, DXY – U.S. Dollar Index, INR – Indian rupee, CNY – Chinese yuan. GBIEMCOR represents the J.P. Morgan GBI-EM Global Core Index, which is comprised of bonds issued by emerging market governments and denominated in the local currency of the issuer.
Important Definitions and Disclosures
Sources of all data: FactSet, J.P. Morgan, and BofA Merrill Lynch. All data as of 2/28/2017.
Correlation measures the degree to which two securities move in relation to each other.
DXY represents the U.S. Dollar Index, which indicates the general international value of the USD. The index represents an average of the exchange rates between the USD and major world currencies.
GBIEMCOR represents the J.P. Morgan GBI-EM Global Core Index, which is comprised of bonds issued by emerging market governments and denominated in the local currency of the issuer.
Indexes are unmanaged and are not securities in which an investment can be made. Index returns are not representative of Fund Returns. For fund returns current to the most recent month-end, visit vaneck.com.
Fran Rodilosso Head of Fixed Income ETF Portfolio Management
Portfolio Manager for Fixed Income ETFs
Oversees the Fixed Income ETF team; responsible for portfolio strategies, as well as credit and market analysis; specializes in international bond markets
Investment Management Team member since 2012
Prior to joining VanEck, Managing Director of Global Emerging Markets with The Seaport Group; launched the firm’s emerging markets fixed income sales and trading business
Previously held portfolio management positions at Greylock Capital and Soundbrook Capital; focused on corporate high-yield and distressed bonds with an emphasis on emerging markets
Earlier career experience includes senior fixed income trading positions at Credit Lyonnais and HSBC
Quoted in Financial Times, Barron’s, and ETF Trends, among others
CFA charterholder; member of New York Society of Security Analysts
MBA (with distinction), Finance, The Wharton School of Business, University of Pennsylvania; AB, History, Princeton University
Time to be Opportunistic in Emerging Markets Bonds
No matter one’s point of view, November was a watershed month for global financial markets. The immediate reaction for holders of emerging markets bonds was to sell first and ask questions later. This sell-then-ask process has been the fate of many risk markets over the past decade. For emerging markets bonds, it did not take long for prices to move significantly lower and then usher in the “ask questions” phase. The market reaction was swift, with higher rates and a stronger U.S. dollar. This continued after the Federal Reserve delivered an expected rate increase following their meeting on December 13-14, but with an unexpectedly hawkish forecast for 2017. Time to be Opportunistic in Emerging Markets Bonds
USD Strength Impacts Local Bonds
Hard currency sovereigns were negatively impacted by a 55 basis points (bps) increase in 10-year U.S. Treasury rates in November, ending the month with a return of -4.1%. Investment grade sovereigns were more impacted than the broader universe due to their longer duration. However, higher quality bonds now also provide an approximately 90 bps pickup versus U.S. investment grade corporate bonds, a significant increase in relative value versus October. High yield emerging markets corporate bonds posted a relatively modest negative return of -1.6% due to a shorter duration than other sectors, and remain a bright spot with year-to-date returns of 14.4%. These gains have been driven equally by the significant carry they provide, as well spreads which have tightened year to date (and which remained steady in November).
Extreme volatility in some emerging markets currencies impacted the local currency sovereign space, which declined 7%, with 5% attributable to currency depreciation and the remaining 2% from higher local rates. Within local currency bonds, Turkey and Mexico stood out as laggards in U.S. dollar terms due to the large selloff in their currencies. Although not immune to the broad weakness in emerging markets currencies, Russian and Colombian bonds were the best performers (although still negative for the month), with the former expected to be more insulated from Trump’s foreign policies, and the latter benefitting from a renewed peace deal with FARC (The Revolutionary Armed Forces of Colombia) and posting small positive returns in local terms. In addition, both Russia and Colombia rely heavily on commodity exports and their local bonds received some support from the increase in oil prices that resulted from OPEC’s (Organization of Petroleum Exporting Countries) announced production limits.
What’s Next for Emerging Markets?
The prevailing sentiment post-U.S. election is somewhat pessimistic for emerging markets. The consensus is that fiscal stimulus will more than make up for monetary tightening, spurring a reflationary trend that is likely to occur inside a newly formed bubble of protectionism that will leave many emerging markets without a key engine for growth. Another by-product is that populist/nationalist movements will succeed (as the rejection of the Italian referendum validated in early December) throughout the developed world over the next several years, significantly altering the geopolitical and economic landscape.
Our view is more nuanced. We believe the prospects for emerging markets in 2017 centers around a few critical questions. One: How will higher U.S. rates, should that trend continue, impact flows? Two: Will the U.S. dollar continue its upward trend on the back of higher rates and a wave of protectionism? And three: Can emerging markets growth continue to recover? Consensus is for growth to accelerate slightly in 2017, but sentiment also appears to be that a fiscally led pick-up in developed markets economies will happen largely in a vacuum as trade relationships are under threat. Given years of progress in the opening of global markets, this last assumption is a difficult one to digest, but it also means that the continued rise of the U.S. dollar is not a foregone conclusion.
Be Savvy and Opportunistic Amid the Volatility
Given the uncertainty in the market, economic and political developments (or even an off-the-cuff early morning tweet by President-elect Trump) are likely to keep volatility elevated in the near term.
We believe investors should keep two things in mind. First, the positive note is that from a static perspective, emerging markets fundamentals (growth, debt stock, real rates, and policy flexibility) remain at a favorable starting point relative to developed markets as we enter 2017. While current accounts are more of a mixed story, in many cases they have improved. On the other hand, the less positive note is that the range of potential outcomes in 2017 – for U.S. rates, growth and inflation, EU and Japanese monetary policy – is extraordinarily wide, with opposite or divergent outcomes possible depending on the course of events. While emerging markets assets can do better in 2017 than recent press and analyst coverage may suggest, we believe that being savvy and opportunistic (and contrarian) about adding exposure could help enhance the risk/reward.
November 2016 1-Month Total Returns by Country
(Click to enlarge)
Source: FactSet as of 11/30/2016. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Current market conditions may not continue.
so Head of Fixed Income ETF Portfolio Management
Portfolio Manager for Fixed Income ETFs specializes in international bond markets
Investment Management Team member since 2012
Prior to joining VanEck, Managing Director of Global Emerging Markets with The Seaport Group; launched the firm’s emerging markets fixed income sales and trading business
Previously held portfolio management positions at Greylock Capital and Soundbrook Capital; focused on corporate high-yield and distressed bonds with an emphasis on emerging markets
Earlier career experience includes senior fixed income trading positions at Credit Lyonnais and HSBC
Quoted in Financial Times, Barron’s, and ETF Trends, among others
CFA charterholder; member of New York Society of Security Analysts
MBA (with distinction), Finance, The Wharton School of Business, University of Pennsylvania; AB, History, Princeton University
IMPORTANT DEFINITIONS AND DISCLOSURES
Sources of all data: FactSet, J.P. Morgan, and BofA Merrill Lynch. All data is as of 11/30/2016.
The information herein represents the opinion of the author(s), but not necessarily those of VanEck, and these opinions may change at any time and from time to time. Non-VanEck proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results. Current data may differ from data quoted. Any graphs shown herein are for illustrative purposes only. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.
This content is published in the United States for residents of specified countries. Investors are subject to securities and tax regulations within their applicable jurisdictions that are not addressed on this content. Nothing in this content should be considered a solicitation to buy or an offer to sell shares of any investment in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction, nor is it intended as investment, tax, financial, or legal advice. Investors should seek such professional advice for their particular situation and jurisdiction.
Please note that Van Eck Securities Corporation offers investment products that invest in the asset class(es) included in this commentary.
Debt securities carry interest rate and credit risk. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. Credit risk is the risk of loss on an investment due to the deterioration of an issuer’s financial health. Securities may be subject to call risk, which may result in having to reinvest the proceeds at lower interest rates, resulting in a decline in income. International investing involves additional risks which include greater market volatility, the availability of less reliable financial information, higher transactional and custody costs, taxation by foreign governments, decreased market liquidity and political instability. Changes in currency exchange rates may negatively impact a Fund’s return. Investments in emerging markets securities are subject to elevated risks which include, among others, expropriation, confiscatory taxation, issues with repatriation of investment income, limitations of foreign ownership, political instability, armed conflict and social instability.
Investing involves substantial risk and high volatility, including possible loss of principal. Bonds and bond funds will generally decrease in value as interest rates rise. An investor should consider the investment objective, risks, charges and expenses of a Fund carefully before investing. To obtain a prospectus and summary prospectus, which contains this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.
The overwhelming influence of G-3 (U.S., Japan, and Europe) monetary policy has been the dominant theme in emerging markets debt this year, and September was no exception. U.S. interest rate volatility leading up to the Federal Reserve (the “Fed”) meeting impacted hard currency bonds, while local currency sovereign bonds were boosted by stronger currencies and lower local interest rates. Overall, accommodative policies and contained inflation continue to provide support, and all sectors of emerging markets debt produced positive returns in September. Emerging Markets Bonds Continue To Rally.
Rate Volatility and Curve Steepening
Interest rate volatility was a primary concern in September as the market grappled with the possibility that the major developed market central banks might be on the verge of policy shifts. The European Central Bank and the Bank of Japan versions of quantitative easing are both under review and the anticipated impact of reversals or tapers led to steeper curves. In the U.S., the Fed remained on hold, as expected, but took a more hawkish tone with regard to the likelihood of a single hike before yearend. Even so, the scaled back rate expectations of Fed governors in the “dot plot” showed only two potential hikes in 2017.
Emerging Markets Credit Developments
Amid the focus on developed market central bank actions, there were several notable credit stories in emerging markets. After the political events of the summer, Turkey lost its investment grade status following a downgrade by Moody’s Investors Service. Some forced selling of Turkish hard currency sovereign bonds will likely occur due to its removal from investment grade indices at the end of October. Hungary, by contrast, regained investment grade status following an upgrade by Standard & Poor’s (S&P), which may support additional inflows in coming months. Turkish spreads widened while spreads on Hungarian sovereign bonds tightened. We continue to have conviction in higher quality hard currency sovereign bonds, and believe they can offer an attractive yield pickup versus core investment grade fixed income sectors, without excessive risk.
On the corporate side, Petroleos de Venezuela S.A. (PDVSA) was downgraded further into junk territory by S&P following the announcement of a proposed debt swap that could be characterized as a distressed exchange. Although a successful swap would buy time by reducing 2017 maturities, clearly the PDVSA and sovereign bonds continue to price in a very high risk of default with yields ranging between 15% and 50% (annualized for shorter maturity bonds in the latter case). The high current yields on the bonds coupled with a price recovery this year as Venezuela continues to apply band aids to its longer term structural problems, have made the country a top performer in the hard currency space year-to-date. In addition, Brazil’s Petróleo Brasileiro S.A. (Petrobras) announced a new spending plan through 2021 that aims to regain investment grade status by reducing leverage, primarily through an ongoing asset sale program.
The mixed ratings actions, and more generally the mixed data through the month reflect the economic diversity within emerging markets. There were inflation upside and downside surprises in September, and although Mexico hiked rates many emerging markets central banks currently appear to favor further easing. Both Indonesia and Russia cut rates, and Brazil may be poised for rate cuts later this quarter. Overall, the fundamental picture in emerging markets continues to brighten, given that real GDP growth is expected to recover this year to 3.9% and further accelerate in 2017, and current account balances are improving as exports increase.
Strong Local Currency Performance As Rates Remain Steady
Returns in the emerging markets debt space have so far in 2016 ranked commensurately with risk. More specifically, local debt has been the top performer, with a total return of 17.08% YTD after a very strong September (2.02%). Although local sovereigns are lower duration by nearly two years versus U.S. dollar sovereigns, currency risk has tended to be a major factor in volatility and returns (though currency movements explain only about 40% of this year’s return through the end of September). Hard currency corporate debt has actually lagged hard currency sovereign debt, but when one considers the greater than two year duration difference between the asset classes in a year when U.S. Treasury yields have moved significantly lower, the performance difference makes sense. In both the sovereign and corporate hard currency space, high yield has performed significantly better than investment grade.
South Africa, Colombia, and Russia were the top performing countries in the local space, while the Philippines, Mexico, and Malaysia posted negative returns, mostly on currency weakness. In contrast to most emerging markets currencies, the Mexican peso has depreciated 11% against the U.S. dollar. In addition to sluggish economic growth, much of the weakness has been attributed to the upcoming U.S. presidential election and the consequences of a potential Trump presidency. Further volatility is possible over the next month.
Hard currency bonds were impacted by U.S. rate movements in the first half of the month, but generally recovered by month end. Sovereign bonds returned 0.40%, with many of the riskier names outperforming as a result of both spread tightening and a lower duration versus higher quality issuers, which were more impacted by the steepening of the yield curve. The same was true for corporate bonds, which finished September with a small positive return overall (0.18%) while the high yield segment returned 1.14% for the month. Emerging markets high yield bonds yielded 0.51% more than U.S. high yield bonds at the end of September, and provided a pickup of 80 basis points in option-adjusted spread terms. The spread advantage tightened 20 basis fallen angels points during the month, driven largely by an influx of Turkish bank “fallen angels” entering the BofA Merrill Lynch Diversified High Yield US Emerging Markets Corporate Plus Index (EMLH or the “Index”). Although these bonds are tighter than the rest of the overall Index, we believe these bonds are trading at spreads that are attractive for BB rated bonds.
Looking Ahead: December Rate Hike Coming into Focus
As we enter the fourth quarter, given the significant gains in emerging markets debt already achieved this year, one might ask: Where do we go from here? Near term uncertainty will likely come from the approaching U.S. elections, the continued positioning of Organization of Petroleum Exporting Countries (OPEC) members and the resulting impact on oil prices, and the precarious capital positions of some European banks. Most significantly, the prospect of a December rate increase in the U.S. will increasingly come into focus. However with a liquidity backdrop that is still very supportive, yields that remain attractive, and fundamentals that continue to improve, we believe that the investment case for emerging markets debt is not likely to be diminished with the next rate hike.
September 2016 1-Month Total Returns by Country
(Click to enlarge) Source: FactSet as of 9/30/2016. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Current market conditions may not continue.
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EMLC
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HYEM
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VanEck Funds EMBAX
Unconstrained Emerging Markets Bond Fund: Class A
Fran Rodilosso Head of Fixed Income ETF Portfolio Management
Portfolio Manager for Fixed Income ETFs
Oversees the Fixed Income ETF team; responsible for portfolio strategies, as well as credit and market analysis; specializes in international bond markets
Investment Management Team member since 2012
Prior to joining VanEck, Managing Director of Global Emerging Markets with The Seaport Group; launched the firm’s emerging markets fixed income sales and trading business
Previously held portfolio management positions at Greylock Capital and Soundbrook Capital; focused on corporate high-yield and distressed bonds with an emphasis on emerging markets
Earlier career experience includes senior fixed income trading positions at Credit Lyonnais and HSBC
Quoted in Financial Times, Barron’s, and ETF Trends, among others
CFA charterholder; member of New York Society of Security Analysts
MBA (with distinction), Finance, The Wharton School of Business, University of Pennsylvania; AB, History, Princeton University
Important Definitions and Disclosures
Sources of all data: FactSet, J.P. Morgan, and BofA Merrill Lynch. All data is as of 9/30/2016.
Quantitative easing is a monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply.
Duration is a measure of the sensitivity of the price of a fixed-income investment to a change in interest rates.
The use of leverage may magnify both gains and losses.
Any indices listed are unmanaged indices and include the reinvestment of all dividends, but do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in a fund. An index’s performance is not illustrative of a fund’s performance. Indices are not securities in which investments can be made.
BofA Merrill Lynch Diversified High Yield US Emerging Markets Corporate Plus Index (EMLH) is comprised of U.S. dollar-denominated bonds issued by non-sovereign emerging markets issuers that are rated below investment grade and that are issued in the major domestic and Eurobond markets.
The information herein represents the opinion of the author(s), but not necessarily those of VanEck, and these opinions may change at any time and from time to time. Non-VanEck proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results. Current data may differ from data quoted. Any graphs shown herein are for illustrative purposes only. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.
This content is published in the United States for residents of specified countries. Investors are subject to securities and tax regulations within their applicable jurisdictions that are not addressed on this content. Nothing in this content should be considered a solicitation to buy or an offer to sell shares of any investment in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction, nor is it intended as investment, tax, financial, or legal advice. Investors should seek such professional advice for their particular situation and jurisdiction.
Please note that Van Eck Securities Corporation offers investment products that invest in the asset class(es) included in this commentary.
Debt securities carry interest rate and credit risk. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. Credit risk is the risk of loss on an investment due to the deterioration of an issuer’s financial health. Securities may be subject to call risk, which may result in having to reinvest the proceeds at lower interest rates, resulting in a decline in income. International investing involves additional risks which include greater market volatility, the availability of less reliable financial information, higher transactional and custody costs, taxation by foreign governments, decreased market liquidity and political instability. Changes in currency exchange rates may negatively impact a Fund’s return. Investments in emerging markets securities are subject to elevated risks which include, among others, expropriation, confiscatory taxation, issues with repatriation of investment income, limitations of foreign ownership, political instability, armed conflict and social instability.
Investing involves substantial risk and high volatility, including possible loss of principal. Bonds and bond funds will generally decrease in value as interest rates rise. An investor should consider the investment objective, risks, charges and expenses of a Fund carefully before investing. To obtain a prospectus and summary prospectus, which contains this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Securities Corporation.
Portfolio Managers Eric Fine and Fran Rodilosso offer their insights on emerging markets debt and how it compares to developed markets debt. Emerging Markets Bonds Roundtable
“[Corporate] defaults in emerging markets tend to happen the same way they happen in developed markets. It’s in the recoveries where differences start appearing….The main difference in that process is that in emerging markets resolutions tends to happen in an extrajudicial fashion, i.e., out of court and on an ad hoc basis.” – Fran Rodilosso
Van Eck is a U.S.-based asset management firm with more than five decades of global investment expertise.
Founded in 1955 by John C. van Eck, Van Eck Global was among the first U.S. money managers helping investors achieve greater diversification through global investing. Today, the firm continues this tradition by offering innovative, actively managed investment choices in hard assets, emerging markets, precious metals, fixed income, and other specialized, domestic and international asset classes. Van Eck currently manages assets on behalf of more than 400 institutions including endowments, foundations, hospitals, pensions, and private banks. The firm’s traditional and alternative strategies are offered in both fund and separate account portfolios.
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