While emerging markets have been riding a wave of synchronised growth more recently, there are a number of external risks that could impact developing economies, according to Jupiter’s Alejandro Arévalo.
The manager of the $104.2 offshore Jupiter Global Emerging Markets Corporate Bond fund, said the volatility seen in emerging market debt markets more recently is now “here to stay”.
“We are very constructive about fundamentals as there have been several events that have tested the robustness of emerging markets over the last 10 years,” he said.
“Whilst some advanced economies are going down in terms of growth, many emerging markets are having a sustainable growth between 2 and 3 per cent.
“But in 2018 I have seen more risks than over the last two years and is very clear now that volatility is here to stay,” he added.
Performance of indices over 3yrs
Source: FE Analytics
While making money from emerging markets over the last two years has been “extremely easy”, Arévalo believes the asset class has entered a new period of “capital preservation”.
The Jupiter manager explained: “We have moved from an asset class where everything was about capital appreciation to capital preservation.”
Arévalo, who also manages the $36.9m Jupiter Global Emerging Markets Short Duration Bond fund, said the reasons are external, with US president Donald Trump’s ‘America First’ policies having negative impact across the world and particularly on emerging markets.
“You continue to see negative headlines about trade and the possible trade war between China and the US,” he said.
“It is obvious that China is trying to mitigate this but it is difficult to get a sense of what Trump wants to do, as one day he sits and negotiates and the next day he changes his mind.”
The manager added: “That type of uncertainty creates volatility as the markets don’t like uncertainty, they want to know what the plan is in a fluid environment.”
Trump’s approach to the North American Free Trade Agreement (NAFTA) and the escalating tensions between the US and its two largest trade partners, Canada and Mexico, is another issue contributing to the uncertainty, according to the Jupiter Global Emerging Markets Corporate Bond fund manager.
Indeed, the latest developments regarding NAFTA negotiations suggest Trump may seek to get individual trade deals with its neighbours, with tensions regarding the US trade relations with Mexico set to continue affecting a key Latin American market.
Another risk on the horizon is the Federal Reserve’s next steps, with rate hikes likely to result in a strengthening of the US dollar, making it more expensive for overseas borrowers to service their debts commitments.
US interest rates since 2007
Source: St Louis Federal Reserve
The political environment in most emerging markets, particularly in Latin America, where elections are scheduled to be held in Brazil and Mexico, is another issue the fund manager said he is watching closely this year.
“Politics in emerging markets is ‘a driving force’ and in 2018 we have a very heavy presidential calendar, especially in Latin America, where we are seeing a tendency of going from right to left,” said Arévalo.
“The main questions are about Brazil and Mexico. Mexico is going to the polls on 1 July and the question is how many votes Andrés Manuel López Obrador, the left-wing candidate, is going to get.”
He said: “Obrador has been very outspoken about changing the reforms the previous government – led by Enrique Peña Nieto – had put in place, which is a risk for Latin America as Mexico is very relevant and can set the tone for risk assets in the region.
“In Brazil it is still very early, with 19 candidates that go from the far-left to the far-right so we have to wait until we see more consolidation.”
The era of low interest rates has also created another risk for emerging market debt in that inflows into the asset class from overseas investors hungry for yield regardless of credit quality have stimulated poor quality new issuances.
“There has been a chase for yield and because of this amount of money we have seen a mispricing of risk,” Arévalo said.
“As a result, companies and sovereigns with very weak fundamentals that weren’t able to issue debt one or two years ago have now been able to tap markets.”
He added: “When we think about the next cycle, those that weren’t able to issue but now are, are the names that are going to underperform and when you have these two things you then have a correction spread.”
But this has also created some opportunities for the manager, as he is starting to see issuers that weren’t paying for the risk before. However, he noted the importance of being selective when exploring the market.
Recent allocations in the Jupiter Global Emerging Markets Corporate Bond fund have included increasing allocation to investment grade and shortening duration while locking bonds’ yields to manage volatility.
“We have decreased duration while keeping the yields of the bonds at the same level, a win-win situation for dedicated investors like us,” he added.
Performance of fund vs sector under Arévalo
Source: FE Analytics
Since taking over the fund in March last year, Arévalo, Jupiter Global Emerging Markets Corporate Bond has delivered a 5.29 per cent loss slightly outperforming the average FO Fixed Interest Emerging Market sector fund, which has lost 5.44 per cent loss.
The fund has an ongoing charges figure (OCF) of 0.79 per cent.