Paul Mohr: Hello and welcome to the Emerging Market Debt Quarterly Perspectives podcast. My name is Paul Mohr. I'm a senior director here with Aberdeen Investments. And each quarter, we break down the key developments in emerging market debt and share our insights on what's ahead in the asset class. Today I'm joined by my colleague, Sid Daya, Global Head of Emerging Market Debt. Sid, welcome back to the podcast. Great to have you on.
Siddharth Dahiya: Great. Thanks, Paul. Thanks for having me.
Paul: Sid, since we last recorded in July, the backdrop has shifted quite a bit. US Treasury yields have moved higher. However, emerging market debt has continued to hold up relatively well. As we look ahead to the final quarter of the year, how would you describe the state of the asset class today?
Sid: Yeah, I think the resilience of the asset class has been one of the biggest stories in the last three months. Treasury yields have moved sharply higher, as we all know. but EM has generally held up relatively well. And that is primarily because fundamentals remain quite strong. Default rates are low, and many issuers or many CUSP issuers have regained market access. We think that this means that we are in a slightly different phase of the cycle. The broad spread compression that was the story of the last couple of years, is no longer in place. We think that returns are increasingly about carry and security selection rather than pure beta. We still find value in high yield, in high yield sovereigns, in select frontier markets, in parts of the corporate universe where yields are attractive. And we also think local markets offer pretty interesting opportunities, given that real yields are still fairly attractive. And longer term, we see prospects for a more supportive effects or local currency environment.
Paul: So that's where we're still seeing value. Let's move over to the geopolitical side of this. And with oil prices have been, well, influx depending on the events of the day in the Middle East. But it's an important theme really for emerging markets and it's been throughout the quarter. How are you guys thinking about the impact of the price volatility we're seeing in the energy sector and how is that impacting emerging markets, whether it's a monetary perspective or otherwise?
Sid: I guess higher oil prices create a very, very clear divide amongst emerging markets. It's a very important issue for our markets. As you know, the beneficiaries generally have been historically have been commodity and energy exporters in places like the Middle East, Kazakhstan, parts of Africa, where particularly those parts of Africa where stronger external balances provide a cushion for other macro issues. Now, this has been slightly challenged because obviously of things going on in the Middle East and even though oil prices are supportive, but volume has taken a hit in some of these countries. Then the more challenged part of our universe tends to be countries, mainly large energy exporters. Those happen to be predominantly in Asia. You can see a very clear divide when it comes to higher oil prices. Now, from a policy perspective, I think higher oil prices can slow the pace of easing in some countries, and we are seeing that already. But the good news is that some emerging market countries started tightening before developed markets and still have fairly attractive, very healthy real yields. And this gives policymakers more flexibility than previous cycles. So we are overall in a comfortable space, obviously, depending on how long this energy shock lasts.
Paul: Yeah, I think I've heard you describe it in meetings as orthodox fiscal policy and monetary policy.
Sid: That's right, yes.
Paul: Well, let's switch gears a little bit to frontier markets. You mentioned some of the African countries there. We've seen a lot of attention on frontier markets this year. There's been efforts to broaden the investor base to local currency with JP Morgan launching their new index. Is there any real meaningful change to the opportunity set for investors given the launch of an index like this? And in particular, are there any markets where improving access or this index inclusion could be a real positive or negative for that matter?
Sid: Yeah, I think it's a very positive development. And it's another sign that frontier markets, frontier local in particular, are slowly becoming a more recognized asset class in their own right. That said, index inclusion doesn't automatically mean investability. Not every market that enters the index will necessarily be easy to access or more importantly, are scalable for large global investors. Some of these markets still face liquidity, accessibility, operational constraints. But nevertheless, the direction of travel is very encouraging. Generally, index recognition improves visibility and research coverage and investor participation over time. Our view is that there are many countries which benefit places like Nigeria, Egypt. Ghana, Kazakhstan, these countries would definitely benefit. Particularly these are places where sort of improving macro fundamentals are matched by improving market access. So these are the places which would likely benefit in the first order.
Paul: And then Sid, we've now seen over the past week or so, Brazil has gone through the first round of their presidential election. There's no clear winner at this point between the younger Bolsonaro and the incumbent Lula. I guess what do you guys make of this outcome and has it changed your thinking about the risks in the country?
Sid: Yeah, I mean, the election in Brazil matters a lot because Brazil remains one of the most important markets across EM, fixed income, both FX, local rates and credit. The market reaction to the first round, you could call it victory of Bolsonaro, itself sort of demonstrated that the outcome for the investment case can change materially depending on political outcomes. Now, our assumption is that our view is that fiscal consolidation will need to be a significant part of the agenda, assuming the first round results are repeated, which is the market based case. And if this sort of commitment or genuine commitment to improving fiscals remains, then market can continue to perform well. But if the discussion becomes more about politics and fiscal consolidation slips down the priority list, then I think the market could be disappointed quite quickly. So for us, what's important is, yes, of course, it's more than who wins, but more important is whether the outcome strengthens or weakens policy credibility and fiscal consolidation happens or not.
Paul: And similarly, in Colombia, there's been a political shift and some subsequent market moves there as well. Kind of taking these two scenarios in concert with each other. Are there any lessons that you guys have or tell us about the approach that the team will take when investing around this political uncertainty?
Sid: I mean, the lesson is that politics does matter to the outcomes for many of these markets. We've seen repeatedly that the right policies can really dramatically improve outcomes. And often they act in a very self-reinforcing way. So credible reforms improves investor confidence and greater confidence reduces risk premium and lower risk premium reduces financing costs and lower financing costs gives policy makers a lot more room to implement difficult or painful adjustments. So it's generally self-reinforcing. It can also work in the opposite direction. Once confidence is lost, financing conditions tighten very quickly. So for us, periods of political uncertainty are not just risk, but they can also create opportunities if we can evidence credibility in policy frameworks returning.
Paul: Interesting. Sid, I want to circle back to one thing real quickly. You mentioned in the beginning that some of the spreads have tightened in the sovereign sector. I think we're seeing similar outcomes in the corporate sector as well. Is there any opportunities where you guys are finding value there or is the story played out now?
Sid: Yeah, EM corporates, as you said, and we've discussed this previously, they continue to be one of the strongest parts of the asset class. Balance sheets are generally very healthy. Leverage remains constructive, conservative, and default rates are low, and technicals are quite positive. One point or one of the things that doesn't get enough attention is that EM corporates have recently outperformed US high yields significantly despite being considered a risky asset class. And I think that really tells you a lot about the resilience of the fundamentals and technicals of each market. When it comes to valuations, yeah, they're certainly tighter than a couple of years ago. just like every other credit market. So selectivity matters. We still find compelling opportunities in places like financials, subordinated financials, infrastructure, utilities, selected commodity stories, etc. So there's plenty of opportunities still. In our view, EM corporates continue to offer attractive combination of yield, defensiveness, and quality.
Paul: So as we look to pull all these themes together, Sid, the resiliency of both the sovereign and the corporate market, energy price volatility, geopolitical factors around the world, What's one of the key messages that you're sharing with investors today as you look forward to investing in emerging markets?
Sid: Yeah, I think the key message is that emerging market debt has matured significantly as an asset class. If you go back 10 years ago, investors used to worry about fiscal sustainability and debt burdens and external vulnerabilities in emerging markets. And I don't want to say it facetiously, but many of these debates are increasingly centered around developed markets these days. So the sentiment has clearly shifted. At the same time, EM continues to offer very attractive carry. And as I mentioned many times previously, fundamentals are improving, and there's a genuinely diverse opportunity set across sovereigns, corporates, local markets, and print and debt. So my message, my general message to investors is that we are moving from purely a beta market to one where stock selection becomes important. The easy gains that were to be had from pure spread compressions are, I would say, are largely behind us. But for active investors such as ourselves, the opportunity set remains very interesting still.
Paul: That feels like a good spot to wrap things up. Thank you as always for sharing your insights with us here.
Sid: Great. Thanks, Paul. Thanks for having me.
Paul: And thank you to all the listeners for tuning in to this quarter's version of the Emerging Market Debt Quarterly Perspectives podcast. To learn more about Aberdeen Investments, emerging market debt capabilities, and access our latest insights, please visit the Aberdeen Investments website. Until next time, thank you all for joining.
This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for informational purposes only and should not be considered as an offer, investment recommendation or solicitation to deal in any of the investments or products mentioned herein, and does not constitute investment research. The views in this podcast are those of the contributors at the time of publication. and do not necessarily reflect those of Aberdeen. The companies discussed in this podcast have been selected for illustrative purposes only or to demonstrate our investment management style and not as an investment recommendation or indication of their future performance. The value of investments and the income from them can go down as well as up and investors may get back less than the amount invested. Past performance is not a guide to future returns, return projections or estimates and provide no guarantee of future results.
