Brazil and Russia should be on debt investor’s radars while Venezuela and Ukraine should be avoided within emerging markets, according to AXA IM’s Sailesh Lad.
Emerging market debt has become a hot topic in recent months among investors looking to find income streams in areas that they may previously have ignored.
With bond yields in the developed world at near all-time lows and equities on stretched valuations leading to lower dividend pay-outs (as percentages) investors have been adding emerging market debt positions, as FE Trustnet reported last week.
Performance of index over 1yr
Source: FE Analytics
As the above graph shows, emerging market debt has been on a positive trajectory over the last year, particularly for the UK investor with the fall in the pound also aiding performance.
On a total return basis, the JPM GBI-EM Global Div Composite has returned 23.29 per cent over the last year in sterling terms.
Below, Sailesh Lad, manager of the AXA World Funds Emerging Markets Short Duration Bonds fund, outlines the areas investors should be looking to add and which to avoid in the space.
The Bad
Starting with the areas to avoid, Lad says there are a two countries emerging market debt investors have been worried about for some time, Venezuela and Ukraine.
“The most obvious country that everyone is nervous about within the emerging market space is Venezuela but people have been worried about the country since the day I started in this industry,” Lad said.
This has stemmed from an inability to pay its debts as well as an overdependence on oil, which has been particularly destructive in recent years.
“Venezuela, like any country, has always had the willingness to pay – because every country and every corporate will say they want to pay their debt – but the question really is about their ability to pay.
“And with oil prices down here [points to floor] I think people are now saying it is only a matter of time before we could potentially see a default there.”
Indeed, as the below graph shows, the oil price has tanked 57.21 per cent in sterling terms over the last three years.
Performance of index over 3yrs
Source: FE Analytics
“I don’t think I am saying anything controversial or different to anyone else in the market right now,” Lad said.
“I think people were talking last year about a default that didn’t happen and this year people thought it would happen in April when we have a big payment coming up.
“But actually people are now saying that they have got just enough to see them through but maybe 2018 is when we really need to worry about it. So it is ongoing but I think everyone is slightly concerned about that.”
Apart from Venezuela the other country he highlights as being of concern to emerging market debt investors is Ukraine, which despite positive developments, he remains wary of.
“Although they [Ukraine] are under an IMF program I think people are concerned with the way it is heading and the speed of the progress,” the manager said.
“When the restructuring happened it was very positive but I don’t think people were very confident that that was going to be the end of it and I would be surprised if there isn’t another restructuring in a few years.
“Having said that I think the market right now is relatively positive on Ukraine because the IMF is still backing them and they are doing the right things albeit a little slower than everyone expected.”
The Good
The first country Lad recommends is Russia, and particularly Russian corporate debt which he has been backing for the last few years.
“If we are to believe Trump and his renewed friendship with Russia I think Russia becomes a country that you want to be invested in,” the manager said.
“For ourselves we’ve got a lot of exposure to Russian corporates and have done since 2015/2016 and the reason behind that is in a perverse way the sanctions put in place have actually helped the Russian corporates.”
Sanctions were placed on Russian exports and visas following the threat to Ukraine’s sovereignty in 2014, with western powers including the US and the European Union imposing bans.
“As a result, when companies have come to market they’ve had to raise cash and de-lever so if you are looking at corporate leverage, Russian corporates have got some of the lowest leverage out there and they’re cashflow positive. So there is no pressure on them to come to market to refinance,” Lad said.
Indeed, while Russian equities have slipped back of late they are among the top performers since Trump was elected, 13 per cent higher since 8 November last year.
Performance of index since US election
Source: FE Analytics
The other country he likes is Brazil, which the manager began to invest in at the tail end of 2015 and is an example of looking at top-down and bottom-up fundamentals.
Lad said: “Brazilian politics and economics all look pretty weak so the top-down investor probably says they wouldn’t touch Brazil as there was an impeachment potential as well as scandals about bribery and corruption.
“But we looked at it slightly differently and said ‘yes the politics don’t look great and the economics aren’t great but actually let’s think about who benefits from this environment – it’s the corporates who are doing their trade with countries outside of Brazil’.
“There they get dollar revenues and for the big exporters the currency depreciated 60 per cent and it doesn’t take a lot to work out which companies are doing business with countries outside of Brazil and not relying on the consumer for their revenues.
The final country he recommends is Argentina, which has been out of the capital markets for over 15 years and in April came back with a $20bn deal and has continued issuance throughout 2016.
“I think the story is still a positive one and the way we look at it is those countries that are willing to do reforms are where we feel most comfortable to be invested because emerging markets goes through cycles,” the AXA IM manager said.
“Now you are getting countries like Argentina, Brazil to some extent, India, Indonesia, those are the sorts of places we feel comfortable investing in right now because we feel momentum is going in the right direction and change is happening.”
The Donald
The outlier in the emerging markets at the moment is Mexico, which has had a tough ride since Donald Trump won the election on the back of protectionist promises. 
“Mexico was probably the darling of the emerging markets for a number of years because they were the one country doing a lot of reforms, closely linked to the US economy and everyone was very happy with it,” said Lad.
“I think if you are looking at Trump then Mexico and China are your two biggest concerns because they’re the two that Trump has highlighted and flagged up and we have been reducing our Mexico exposure – we started pre-election and we continue to do so.
“But we’ve also been quite selective about some of the names that we have bought since then as well.
“As much as he says he’s going to build a wall, he’s going to put in these trade tariffs, you’ve got to understand that the Mexican peso has depreciated quite significantly.”
He added: “It’s very easy to say we are going to stop buying auto parts from Mexico and start building them here but you cannot build a factory overnight.
“You cannot have all the infrastructure in place overnight – it takes a number of years to do that and our analysts have met with companies and to be fully up and running I think it takes four to five years.
“If you take the currency effects into that it is cheaper to buy those goods from Mexico than it is the US so you have to go to the consumer and say ‘you want to make America great but are you willing to buy your car that is $2,000-3,000 more expensive than it was pre-this trade barrier’ and I’m pretty sure people are going to say no.”
“You’ve got to be very selective in the names you are buying. There are a lot of food producers that are doing all their business in America and they will likely be unaffected.”