Examining emerging market debt

Market volatility in March wreaked havoc on risk assets, including emerging market (EM) bonds. Richard Lawrence held on for the ride and came out the other side with his EM outlook little changed.

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“We actually still like the positions we own in the EMD [emerging market debt] countries we’re exposed to,” said Lawrence, senior vice-president of global fixed income at Brandywine Global Investment Management in Philadelphia, Pa., in a May 18 interview. His firm manages the Renaissance Global Bond Private Pool and the Renaissance Global Bond Fund.

At the year’s start, his EM outlook had been positive.

“We came into the year thinking that, overall, we were looking at an environment with diminished macro risk for emerging market economies,” Lawrence said, citing the U.S.-China trade deal and supportive monetary policy globally.

“In fact, in the first couple of months of the year, we saw a steady decline in yields in emerging market bonds around the world,” including Mexico, Indonesia and Brazil, he said.

Then came the Covid-19 outbreak and subsequent market turmoil.

“That middle two weeks of March created carnage — very temporarily — in emerging market bonds,” Lawrence said. “Over the course of about nine to 10 days, we saw yields explode wider — in Mexico, Colombia, Indonesia.”

For example, the Mexican 10-year had a yield of 6.9% at the start of the year and rose to 8.3% at the peak of the market volatility. By mid-May, the yield was 6.1% — lower than at the year’s start and where it still remains.

“Once you got through that very risky period in the middle of March, the underlying macro fundamentals in emerging markets still look intact,” Lawrence said. “That’s a story that’s played out in Colombia, Indonesia, our positions in South Africa [and] in Brazilian bonds.”

Lawrence hadn’t increased his funds’ exposure to EM debt, however.

“It’s not that we don’t like the opportunities there,” he said. “We’ve just got the portfolios balanced right now, with another very interesting opportunity in investment-grade credit in the U.S.”

In response to the pandemic, the Federal Reserve’s monetary policy has included large-scale asset purchases, including corporate bonds.

“With the Fed stepping in and being willing to backstop investment-grade corporate credit in the U.S., we’ve seen a lot of high-quality issuers come to market,” Lawrence said.

His firm had been participating in a number of deals in the primary market, he said, adding “a lot” of these bonds at attractive prices. The additions create a “nice diversifying risk to the emerging market debt exposures that we still have and still like in the portfolio,” he said.

That diversification may be particularly important as the virus impacts emerging markets later relative to Asia, Europe and North America. Lawrence said he was watching the infection rates in Brazil and Russia, in particular. After the U.S., those two countries account for the most cases of the virus.

Within investment-grade credit, Lawrence said he’s avoiding energy and favouring names in the technology, industrial and consumer sectors.

Disney, UPS, Intel, Coca-Cola, Wells Fargo and McDonald’s all make the cut. Lawrence described them as high quality, with strong balance sheets and solid free cash flows.

“But they all came to market at significantly wide spreads,” he said. As of mid-May, some of them were up 30 to 40 basis points from when he bought them.

“We still think there’s the opportunity for further spread compression from here,” he said.

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