Bond Investors Find Opportunities in Reforming Countries

Countries actively undertaking reforms – such as China, Argentina, Mexico and Ukraine – will be among the fixed income winners over the longer term say Neuberger Berman 

External Writer 10 February, 2016 | 1:50PM
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Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Rob Drijkoningen, co-head of emerging market debt comments on the Neuberger Berman Short Duration Emerging Market Debt Fund, as part of our Guide to Income Investing.

Emerging markets have experienced a challenging environment over the past year – with fundamentals tested by headwinds related to commodity prices, currencies, and slower growth in China. We believe uncertainties related to China are likely to persist and markets will attempt to find a supply/demand balance in commodity prices.

Despite these challenges, we believe emerging markets are in a better position than many of today’s headlines suggest. For example, Asia has benefited from being an importer of commodities; also emerging market currencies adjusted to the new realities working like a safety valve, protecting creditworthiness and providing support for dollar based investment possibilities. 

Overall emerging market sovereign credit quality also remains supported by strong public sector balance sheets, low external debt ratios and large FX reserves. Emerging market corporates have been proactive in efforts to reduce costs, capex and dividends – as well as engage in liability management exercises to improve balance sheets. Moreover, new issuance levels remain fairly contained which will provide good technical support to the emerging market debt asset class.

Finally, after the recent backup in spreads, we believe valuations for emerging market hard currency bonds are reasonably attractive.

A Focus on Eastern Europe, Middle East and Africa

Investors will face a wider dispersion between winners and losers over the coming year. We believe countries actively undertaking reforms – such as China, Argentina, Mexico and Ukraine – will be among the winners over the longer term.

From a regional perspective, the Central and Eastern Europe, Middle East and Africa region has the largest weight in the portfolio at present, consisting of more than a dozen countries with different profiles.

Turkey and Russia are the largest holdings in this region, as we see value in both short-dated sovereigns and corporate names in those countries.

On the more defensive side, we continue to hold positions in countries such as Hungary and Slovenia; countries where we see fundamental improvements and which are expected to be less impacted from broader emerging market weakness or further pressure on commodity prices.

In Asia, China represents the largest single country weight. Even though the challenges for China are real, we believe the world has more problems with the China slowdown than China itself. We hold positions in high quality quasi-sovereign entities in China, as well as several corporate bonds in sectors like real estate – where we see credit quality improving and we think will continue to benefit from policy stimulus.

Finally in Latin America, Brazil is our largest holding, as we believe sovereign spreads are attractive versus similar high yield rated peers and more than compensate for the economic challenges and political stalemate. We also find value in the corporate space, such as in the beef sector, as these are mostly exporters not suffering too much from those domestic challenges and profit from the weak local currency.

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