EM debt ‘extremely attractive’, says Ashmore’s Dehn
Jan Dehn, co-head of research at Ashmore Investment Management, discusses the expected impact of the forthcoming European Union budget summit.
– Thursday’s two-day European Union budget summit in Belgium may prove noisy, but is largely irrelevant to the fiscal health of its member states.
– The broad trend is for more national spending to migrate to the EU as the European Union continues to integrate. Rising EU spending presents specific political challenges for countries such as the UK, whose government is undertaking austerity and does not support closer fiscal integration.
– However, the EU budget itself is not the cause of Europe’s fiscal problems, which lie squarely with national governments, whose debts are still rising despite efforts to reform. These problems are the result of years of fiscal profligacy.
– Europe’s long-term path is towards fiscal union. The next step in this process is likely to be EU-wide banking regulation as a possible pre-cursor for a European version of TARP (forced recapitalization of Europe’s banks). This will further increase Europe’s already excessive debt burden.
– Investors in government bonds of the Europe Union and other HIDCs (Heavily Indebted Developed Countries) face significant risks, including default (either out right or via inflation and currency depreciation). HIDC bonds are significantly more risky than prices suggest, because bond prices are kept artificially elevated by central bank intervention. They constitute an extremely poor value proposition, in our view.
– Prudent fixed income investors should avoid HIDC bonds altogether in favour of a diversified portfolio of Emerging Market bonds. Emerging Market bonds are less risky and pay more.
– Emerging Markets have ten times less debt, fives times stronger growth, and control some 80% of the world’s foreign exchange reserves. Some three quarters of Emerging Market issuers are now investment grade. They trade several hundred basis points wide of HIDC bonds. They constitute an extremely attractive value proposition, in our view.