– Growing regional opportunities for this asset class will come from new issuance in Kuwait, recovering oil prices and reforms in Qatar, Abu Dhabi and Saudi Arabia
– The risk/reward scenario warrants attention on EMD from investors because that’s where the structural risk premium and abundant alpha opportunities reside, says Valentina Chen, Co-Head of the firm’s EMD team.
– Based on J.P. Morgan’s EMBIG Diversified Index, EM investment grade debt is offering a yield of more than 3%, its high yield component is generating a yield of over 7.5% and the overall index is returning a yield of above 5%
UAE, 30 March 2021 – Middle East institutional investors stand to benefit from the strategic role of emerging market debt (EMD) in portfolios this year, despite macro, geopolitical and market uncertainties, according to BMO Global Asset Management (BMO GAM).
“From higher yields to enhanced diversification, the asset class offers several benefits,” said Valentina Chen, Co-Head of the firm’s EMD team.
Based on J.P. Morgan’s EMBIG Diversified Index, EM investment grade debt is offering a yield of more than 3%, while its high yield component is generating a yield of over 7.5%. The overall index is returning a yield of above 5%. “Institutional investors cannot afford to ignore this asset class given the current yield-scarce backdrop,” added Chen.
In the GCC, BMO GAM forecasts abundant opportunities, stemming from trends that should boost the weighting of GCC in the J.P. Morgan index. These include:
- Pending new issuance from Kuwait
- Reform agendas in Qatar, Abu Dhabi and Saudi Arabia – easing budget reliance on oil prices amid declining fiscal break-evens relating also to growth in non-oil sectors
- The recent ending of the blockade of Qatar – to help normalize intra-regional trade
- UAE and Bahrain signing the Abraham Accords with Israel – with expectations of trade and investment into non-oil sectors
“GCC countries are a very important part of the EM hard currency universe and currently make up nearly 15% of the J.P. Morgan index,” explained Fadi Khoury, Managing Director and Head of Client Management and Distribution for BMO GAM in MENA.
In line with this, the strong contribution of the GCC to the overall credit quality of the EM hard currency asset class bodes well for the many locally based institutions seeking a pick-up in yield. “These investors are already comfortable with EMD given they are working in an emerging market,” added Khoury.
Other hot spots that Chen foresees in the EMD space include:
- EM hard currency high yield sovereigns that are commodity exporters (e.g. Brazil) or having structural reforms in place (e.g. Dominican Republic)
- EM hard currency investment grade sovereigns which have been oversold (e.g. Philippines)
- EM currencies in general, given their cheap valuation, global growth pickup and supportive commodity backdrop
Rewarded with promising returns
Although a vaccinated global economy should benefit all markets, China-led expansion is likely to accelerate recovery across EM.
“Over the next few quarters, we anticipate EMD will benefit from increased economic growth, a gradual recovery in the tourism industry, a positive commodity outlook and overall still supportive global liquidity,” said Chen.
“We believe the risk/reward scenario warrants attention on EMD from investors because that’s where the structural risk premium and abundant alpha opportunities reside,” she added.
In EM hard currency sovereign bonds, for example, the structural risk premium has been approximately 370 basis points (bps) on average per year over the last two decades, with a realized default-related loss of approximately 50 bps per year, according to J.P. Morgan.
“Investors in this subset of EMD are therefore extremely well compensated for the risk they incur,” explained Chen.
Investors also need to persist with EMD, rather than jump in and out of the asset class because of potential tail events, based on BMO GAM analysis. The latter half of 2020 was evidence of the likelihood of a sharp market rally period immediately after a period of negative performance.
“By staying the course, asset owners and managers should be able to capture the risk premium long term, instead of potentially ill-timing the market,” said Khoury.
Meanwhile, there is increasing scope for investors to incorporate ESG factors in focused EMD investments, without compromising returns, reflecting the growing emphasis on responsible investments over the past 12 months.
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