Navigating Emerging Market Debt Flows

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Emerging markets hard currency debt funds have experienced large outflows over the last 11 weeks, totaling approximately $16 billion—the longest period of outflows since 2016. The current environment has left many questioning the cause and duration of the selloff. Despite the negative headlines, we believe value has been created across the broad EMD asset classes as credit spreads have widened by more than the changes in fundamentals warrant.

In our view, investor redemptions are no surprise given the poor recent price performance and modest fundamental deterioration across select emerging markets credits. Broadly, US dollar appreciation during the second quarter 2018 drove some of the deterioration. The strengthening dollar had a modest negative affect across the emerging market debt universe as nominal GDP and debt repayment capacity in local currency depreciated relative to USD-denominated debt. Additionally, a few well-narrated sovereigns with largely idiosyncratic situations—Turkey, Argentina, and Brazil—experienced fundamental and material price deterioration.

A closer look at flows

Transactions typically set prices – therefore we can infer that yesterday's flows are largely responsible for yesterday's prices. However, perhaps yesterday's flows can help us tactically understand tomorrow's prices. Using the iShares USD Emerging Market Bond ETF (EMB) as an example (Exhibit 1), price performance has been positively biased after large outflows in contrast to all other periods of neutral price performance.

Exhibit 1 – Larger EM outflows have historically resulted in greater future returns
Median future returns of EMB relative to change in shares outstanding
December 31, 2010 – July 6, 2018


Source: Bloomberg. Includes weekly data on iShares USD Emerging Market Bond ETF (EMB) from December 31, 2010 through July 6, 2018.

Putting the recent outflows into perspective

We believe it's relevant to view the near-term outflows within the context of a longer time horizon. Exhibit 2 depicts historical net asset value and shares outstanding in iShares USD Emerging Market Bond ETF. This view demonstrates that the previously noted outflows are only remarkable within a very narrow timeframe. Using this ETF as a proxy for the emerging markets asset class, we can infer strong and continued investor support for the opportunities presented in the market.

Exhibit 2 – Recent outflows were a minor blip within the context of a longer timeframe
Asset value and shares outstanding of iShares USD Emerging Market Bond ETF (EMB)
December 31, 2010 – July 6, 2018


Source: Bloomberg. iShares USD Emerging Market Bond ETF (EMB) from December 31, 2010 through July 6, 2018.

Opportunities persist in emerging markets

In our view, value has been created across the broad EMD asset classes as credit spreads have widened by more than the changes in fundamentals warrant. Further, of the three credits highlighted above, Turkey and Argentina currently present compelling investment opportunities.

Despite the negative headline sentiment for the asset class, we maintain our constructive view of emerging markets debt. The appealing fundamentals of our favored countries, a recent cheapening of the asset class, and favorable technicals underpin our positive outlook on emerging markets debt over the short and longer term.

 

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Past performance is not indicative of future results. All investments contain risk and may lose value. Investing in foreign-denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, economic and political risks, which may be enhanced in emerging markets. Investors should consult their investment professional prior to making an investment decision. Results for certain charts and graphs are included for illustrative purposes only and should not be relied upon to assist or inform the making of any investment decisions.
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Phil Torres

About Phil Torres

Phil Torres is global co-head of emerging markets and director of emerging markets research. As co-head of emerging markets, Phil is a portfolio manager for the firm's international fixed income portfolios investing primarily in emerging market debt and local markets. He is also responsible for overseeing the Emerging Markets Research team. Prior to his current role, Phil was the founding partner and co-portfolio manager of the Harbert Macro Fund, an emerging markets global macro hedge fund. Prior to that, Phil worked as a portfolio manager at UBS Asset Management, JBS USA, Vara Capital Management, and Ritchie Capital Management. He has 23 years of industry experience and has been with the firm since 2016. Phil received his BA from Tufts University and his MBA from the University of Chicago.