Short duration EMD may offer more reward for less risk
A balanced Federal Open Market Committee announcement by the Federal Reserve (Fed), confirming its policy of progressive tightening, continues to provide a broadly supportive environment for emerging market (EM) debt which, at the short duration end, appears cheap relative to any developed credit market.
The spread offered for EM credits over the US or eurozone presents significant spread premia of 60-100% at each rating level (AAA through to BBB, BB, B and so on). In the short duration market, investors are receiving more reward for credit risk but for generally lower duration, so there is potentially less market risk.
Even if US rates rise, as long as the rise is well flagged and progressive, it should continue to support the asset class and we should continue to enjoy the 5% carry the AXA WF Emerging Market Short Duration Bonds exposure offers. In addition, the European Central Bank, Bank of Japan and Bank of China – are still providing liquidity to the global system. A less positive outcome for the asset class would be if the Fed revealed a big hawkish surprise or loses its credibility with markets – something we don’t believe should happen for now.
Within AXA WF Emerging Markets Short Duration Bonds, we favour those countries with a credible mix of both monetary and fiscal policies and governments with a clear intention to engage in reform. Additionally we like countries which are geared towards growth areas such as the US and to a lower extent, China, or whose domestic reform dynamics are a boost for the local economy. These countries include; Mexico, Colombia, Korea, Malaysia, Philippines, India, Indonesia and Romania. We hold a less favourable view of countries where the policy backdrop is either less credible or unsustainable such as Turkey, South Africa and Russia. Recent geopolitical issues remain largely contained though, and the market has differentiated between risks across Russia, Ukraine, Iraq and the Argentine default. We therefore don’t believe there is a real nor lasting impact in terms of macro contagion across the EM world.
Liquidity concerns are the same for every credit asset class. We don’t expect this to change imminently, however there is always a risk that this could occur and therefore we want to be on the cautious side. This is why we have stepped up our exposure to more liquid sovereign and quasi-sovereign investment grade bonds, which provide better fundamental visibility, together with a higher degree of liquidity given larger issuance sizes. With this in mind, we have reinvested in short duration credit in Mexico, Colombia, Turkey and Indonesia. We pay strong attention to the liquidity risk of the portfolio and make adjustments according to the level of liquidity that the market is able to accept, calibrating our positions to the market conditions and we use sovereign and quasi-sovereign credits, from bigger issuers to smooth the liquidity profile of the fund.
Damien Buchet is AXA IM’s head of Emerging Markets, Fixed Income.