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Green and Sustainable Bonds in Emerging Markets

BARTON-Mary-Therese-490 — Mary-Therese Barton, Pictet Asset Management. Mary-Therese Barton, Pictet Asset Management

Governments everywhere are racing to lock in historically low borrowing costs by issuing ever longer dated debt – in recent years Mexico and Argentina even managed to sell century bonds. That presents several new challenges for fixed income investors. Particularly those who own emerging market bonds.

Not only do bondholders have to weigh the usual near-term factors like political, economic and commodity cycles but, in lending money to sovereigns over such extended periods, they now also have to consider the impact of longer term trends such as climate change and social development. Both can affect creditworthiness in profound ways.

This has called for new approaches to investment thinking. Economic and financial forecasts are having to be recast with climate dynamics in mind. Meanwhile, modelled pathways of climatic change are themselves subject to expectations about future technological change as well as the evolution of political thinking in these countries. The number of moving parts only grows as investors realise they also have a role to play in shaping how governments approach making their economies sustainable and low-carbon.

It’s a complex problem. But not an insurmountable one.

The greening of EM debt

In 2015, some 17 per cent of emerging market hard currency debt had a maturity of 20 years or more. By the start of 2021, that proportion had grown to 27 per cent. Even local currency denominated emerging market debt, which tends to be shorter-dated, has moved along the maturity curve. Over the same time period, the proportion of local currency debt with a maturity of five years or longer had risen 11 percentage points to 58 per cent (1).

That shift reflects growing demand for yield from investors starved of income. But at the same time, bondholders have recognised the importance of taking a long-term view on environmental issues. This is apparent in both the appetite for green bonds – capital earmarked for environmental- or climate-related projects – and, more generally, bonds that fall under the environmental, social and governance (ESG) umbrella.

Governments are happy to meet that demand. Increasingly, they recognise the need to make efforts to mitigate climate change, and given that emerging market economies make up half the world’s output, they have a significant role to play in meeting global greenhouse gas emissions goals.

In the five years to the end of 2020, annual issuance of green, social and sustainability bonds by emerging market governments grew nearly four-fold to USD16.2 billion (2). And demand is only increasing. For instance, in the first few weeks of January, Chile met 70 per cent of its expected USD6 billion debt issuance for 2021, all in green and social bonds and it plans only to issue sustainable and green bonds during the remainder of the year (3). In September 2020, Egypt became the first Middle Eastern government to issue a green bond. It raised USD750 million to finance or refinance green projects. Investors were enthusiastic – the bond was five times oversubscribed (4).

And generally, these bonds have longer maturities than conventional fixed income securities. Some 46 per cent of USD36.8 billion of outstanding emerging market ESG bonds priced in local currency terms have a maturity of more than 10 years, while for emerging markets hard currency ESG bonds, it’s 41 per cent of USD12.9 billion of outstanding bonds (5).

These bonds allow investors to track performance, while green agendas can also help governments to improve their credit ratings, which then lifts the value of their debt, thus rewarding bond holders.

Overall, green bonds generate positive feedback effects. The rising volumes of green and sustainable bond issuance highlights investors’ willingness to take more of a long-term approach to EM investing. But at the same time, governments are being made more accountable – in order to issue these bonds, governments are having to publish their sustainability frameworks in greater detail. This additional accountability helps to mitigate political risks that are a key consideration in EM investing. Investors, however, will need to analyse and monitor developments closely to ensure proceeds are used as intended.

Indeed, green bonds are the most exciting development in emerging market financing for decades and, we think, will have an equivalent impact to the Brady bonds of the 1980s (6) – albeit this is dependent on improved disclosure and monitoring and industry standardisation of green labels.

Climate change matters (especially in EM)

For all the sovereign issuance of green bonds so far, a great deal more funding will need to be raised to limit climate change. Globally it will cost between USD1 trillion and USD2 trillion a year in additional spending to limit global warming, some 1 per cent to 1.5 per cent of worldwide GDP, according to the Energy Transitions Commission (7). And a significant part of those costs will need to be borne by emerging economies, not least because they are likely to suffer most.

By the end of this century, unmitigated climate change – entailing warming of 4.3° centigrade above pre-industrial levels – would cut per capita economic output in major countries like Brazil and India by more than 60 per cent compared to a world without climate change, according to a report by Oxford University’s Smith School sponsored by Pictet (8). Globally, the shortfall would be 45 per cent.

Limiting warming to 1.6° C would sharply reduce that hit to roughly 27 per cent of potential output per capita for the world as a whole, albeit with considerable variation among countries. While those in the tropics countries would be hit hard by the effects of drought and altered rainfall patterns, those in high latitudes, like Russia, would be relative winners as ports become less ice-locked and more territory is opened up to extractive industries and agriculture. And though China would suffer smaller overall losses than average, its large coastal conurbations would be subject to depredations caused by rising sea levels.

Integrating risks

As these effects are felt, investors will grow increasingly wary of lending to vulnerable countries. And climate change is already having an impact on developing countries’ credit ratings. In 2018, rating agency Standard & Poor’s cited hurricane risk when it cut its ratings outlook on the sovereign debt issued by the Turks and Caicos (9).

Investors could expect climate-related events, like droughts, severe storms and shifts in precipitation patterns, to push up output and inflation volatility in emerging economies during the next ten to 20 years, according to Professor Cameron Hepburn, lead author of the Oxford report.

That would represent a significant reversal for emerging market sovereign borrowers. Since the turn of the century the relative rate of growth and inflation volatilities between emerging and developed markets has halved (10), which, in turn, has reduced the risk faced by investors. Rising economic volatility would feed into sovereign risk assessments, eroding their credit profiles.

Other research from the Oxford team highlights the choices countries will need to take to remain on the path towards building a greener economy (11).

At Pictet Asset Management, we already use a wealth of ESG data – from both external and internal sources –as part of how we score countries. The environmental factors we monitor include air quality, climate change exposure, deforestation and water stress. Social dimensions include education, healthcare, life expectancy and scientific research. And governance covers elements like corruption, electoral process, government stability, judicial independence and right to privacy. Together these factors are aggregated to become one of six pillars in the country risk index (CRI) ranking produced by our economics team.

Level playing fields

We believe that ESG considerations are inefficiently reflected in emerging market asset prices. This is a consequence of the market still being at an early stage in its understanding and application of ESG factors and analysis. There is also a lack of consistent and transparent ESG data for many emerging countries. We believe that using an ESG score alone is simply not enough. Having a sustainable lens through which to examine emerging market fundamentals helps us to mitigate risk and unearth investment opportunities. We use our own ESG data and analysis and engage with sovereign bond issuers to help bring about long-term change.

Emerging market economies vary hugely in their degree of development. This complicates how investors should weigh their ESG performance – after all, richer countries are more able to make the ESG-positive policy decisions that often have high front end costs for a long tail of benefits, such as shutting down coal mines in favour of solar power.

Applying the most simplistic approach to ESG – investing on the basis of countries’ ESG rankings – would squeeze fixed income investors out of the poorest developing countries, even if they are implementing the right policies to improve their ESG standing. Instead, it’s important for investors to recognise what is possible and achievable by poorer countries and allocate funding within those constraints – understanding countries’ direction of travel in terms of ESG is critical to analysing their prospects.

One solution we are implementing at Pictet AM is to weigh ESG criteria against a country’s GDP per capita. So, for example, under our new scoring system, Angola does well on this adjusted basis despite having a low overall ranking. And the reverse is true for Gulf Cooperation Council member states.

Dynamic approaches

How governments react to long-term issues like climate change or to the challenge of developing their human capital will influence their economies’ trajectories and, ultimately, play a role in their credit ratings. Those long-term decisions are only growing in importance, not least given the scale of fiscal policies implemented in the wake of the Covid-19 pandemic. Tracking these spending programmes – through, say, the likes of the Oxford Economic Stimulus Observatory (12) – then becomes an important step towards understanding the ESG pathways governments are likely to follow.

Countries with good, well-structured policies are likely to see their credit ratings improve, which attracts investors, drawing funding into their green investment programmes and ultimately driving a virtuous investment cycle.

Engaged investors

All this implies that investors have an active role to play – they can’t just passively allocate funding based on index weightings or be purely reactive to policymakers’ decisions. The most successful investors will help steer governments towards the path that boosts their credit ratings, gives them most access to the market and improves the fortunes and potential of citizens.

Like, for instance, explaining how electricity generated by wind turbines or solar can prove to be more cost-effective over the long term if financed by green bonds than ostensibly cheaper coal extracted from a mine paid for with higher yielding conventional debt. Or how fossil fuel investments could prove to be major white elephants as these sorts of polluting assets become stranded by shifts towards cleaner energy production. Or that failing to invest enough in education is a false economy that over the long run will fail to make the most of human capital and thus depress national output – something we raised with the South African government after our meetings with our on-the-ground charitable partners in the country.

To that end, The World Bank produced in 2020 a timely guide on how sovereign issuers can improve their engagement with investors on ESG issues (13).

This sort of intensive analysis – using everything from long run macro models down to meetings with leaders of youth clubs in impoverished districts – can also help to paint a rounded picture of what’s happening in a country. For instance, it helped to ensure that we weren’t caught off guard by the shift to populism in Argentina ahead of their last elections and allowed us to trim our positions in the country.

For emerging market investors, ensuring all of these cogs mesh correctly is a difficult proposition, especially given that the parts are moving all the time, many driven by forces that will develop over many decades. But by using the full breadth of analytical tools, independent research and shoe leather fact-finding, it’s possible to gain a deeper and more profitable insight into these markets than a simple reading of credit ratings or index weightings offers. And, at the same time, influence policy makers to champion their country’s sustainable initiatives. Taking a sustainable approach to growth and issuing related bonds, emerging economies can fundamentally change their prospects for the better. It has the potential to be revolutionary for emerging markets and exhilarating for those of us who invest in them.

Written by Mary-Therese Barton, Head of Emerging Markets Debt at Pictet Asset Management.

Notes:

(1) JPM EMBI-GD and GBI-EM. Data as at 25.01.21.

(2) Ibid

(3) https://www.latinfinance.com/daily-briefs/2021/1/22/interview-chile-diversifies-investor-base-with-esg-bonds

(4) https://www.reuters.com/article/egypt-bonds-int-idUSKBN26K1MJ

(5) Source: Pictet Asset Management, Bloomberg. Data as at 25.01.21

(6) Brady bonds were an innovative debt reduction programme in response to the Latin American debt crisis of the 1980s, involving the issuance of US dollar denominated bonds.

(7) https://www.reuters.com/article/uk-energy-transition/global-net-zero-emissions-goal-would-require-1-2-trillion-a-year-investment-study-idUKKBN2670OA?edition-redirect=in

(8) Hepburn, C. et al. “Climate Change and Emerging Markets after Covid-19.” November, 2020. Estimates based on the Intergovernmental Panel on Climate Change’s shared socioeconomic pathway 2 (SSP2) using cmip5 climate models.

(9) https://www.spglobal.com/marketintelligence/en/news-insights/trending/vep0j9mtowo52rlsmmww9g2#:~:text=S%26P%20Global%20Ratings%20revised%20its,two%20major20major%20hurricanes%20last%20year.&text=S%26P%20expects%20real%20GDP%20to,average%20from%202019%20to%202021.

(10) Average of rolling 2-year standard deviation of growth and inflation rates for 27 EM countries relative to 25 DM countries. Source: Pictet Asset Management, CEIC, Refinitiv. Data 01.01.2000 to 01.01.2021.

(11) https://www.researchgate.net/publication/340509193_Economic_complexity_and_the_green_economy

(12) https://www.ouerp.com/totaltracking

(13) https://www.worldbank.org/en/news/press-release/2020/11/08/world-bank-releases-guide-for-sovereign-issuers-to-engage-with-investors-on-environmental-social-and-governance-esg-issues

Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to risks and uncertainties that could cause actual results to differ materially from those presented herein.

Important notes

This material is for distribution to professional investors only. However it is not intended for distribution to any person or entity who is a citizen or resident of any locality, state, country or other jurisdiction where such distribution, publication, or use would be contrary to law or regulation. Information used in the preparation of this document is based upon sources believed to be reliable, but no representation or warranty is given as to the accuracy or completeness of those sources. Any opinion, estimate or forecast may be changed at any time without prior warning. Investors should read the prospectus or offering memorandum before investing in any Pictet managed funds. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Past performance is not a guide to future performance. The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested.

This document has been issued in Switzerland by Pictet Asset Management SA and in the rest of the world by Pictet Asset Management Limited, which is authorised and regulated by the Financial Conduct Authority, and may not be reproduced or distributed, either in part or in full, without their prior authorisation.

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Pictet Asset Management: Inflation Worries Overblown

| For Meritxell Sedo | 0 Comentarios

The head of steam building up behind the global economy is becoming ever more evident. As vaccination programmes allow Covid-related restrictions to be lifted, growth looks set to jump, with the economy likely to recover much of last year’s losses.

Bond yields have risen on doubts about central banks’ ability and willingness to remain accommodative in the face of strong growth, the impact of President Joe Biden’s additional USD1.9 trillion stimulus package and because inflation expectations appear to be already broadly in line with official targets.

But we think these concerns are premature. Any overshooting of central bank’s inflation objectives is likely to be only temporary, given large amounts of spare capacity in the economy. We don’t see underlying inflation picking up for at least the coming year. All of which leads us to maintain our overweight bias on equities and our neutral stance on bonds.

Our business cycle indicators show that momentum remains strong, prompting our economists to once again raise their real GDP growth forecasts for 2021 . We now expect the global economy to grow by a real 6.4 per cent this year against a market consensus of 5.1 per cent, with emerging economies, spearheaded by China and India (seen growing by a respective 9.5 per cent and 13.1 per cent) leading the way.¹ But the US is also poised for a robust 6.5 per cent expansion, according to our forecasts, more than making up for last year’s 3.5 per cent contraction. That’s underpinned by a surge in retail sales – it looks like Americans are beginning to spend their stimulus cheques – and a robust response by industry to fill that demand.

Base effects are likely to push inflation temporarily higher. It’s worth remembering that oil prices were briefly negative a year ago – now they’re roughly back to where they were before the Covid crisis. Meanwhile, as economies open up, we think the services sector will respond quickly to absorb pent-up demand and we’re likely to see few of the bottlenecks that typically give rise to underlying price pressures. In the US, any inflationary overshoot caused by excessive stimulus isn’t likely to appear until 2022/23, which should allow the US Federal Reserve to avoid tightening policy for the next 12 months or so.

Our liquidity indicators show that the pace of monetary growth is slowing substantially. The rate at which money supply is rising is still above average, but well down from last year’s peaks. Over the near term, liquidity provision should continue to support riskier assets. In the US, for instance, money creation is off the chart, with the M1 money supply measure expanding 76 per cent on the year and M2 up 28 per cent. But on the other side of the Pacific, there are signs of restraint. The Bank of Japan is slowing its quantitative and qualitative easing programme, its yield curve control policy seems to have been relaxed somewhat. In China, the growth in the volume of credit flowing through the economy has slowed and the central bank has indicated a tightening bias.

Our valuation indicators show most riskier asset classes trading at or near record highs. Valuations for stocks in the MSCI World index are at their most expensive since 2008 according to our models, with the market pricing in a return to pre-Covid rates of economic growth but with permanently lower interest rates.

We expect around a 20 per cent fall in the global price-to-earnings multiple as real yields start to rise and excess liquidity begins to dissipate. However, we also see a big jump in earnings per share growth (see equities section and Fig. 2) as both sales and profit margins benefit from a normalisation of economic conditions and generous fiscal support. The combined effect suggests around a 10 per cent upside for US equities from here.

As for fixed income, the recent rise in yields means that government bonds aren’t trading far away from their fair value for this stage of the economic cycle. For the first time since the pandemic struck, US 30-year real yields are in positive territory. But that rise in yields also makes equities look a little more expensive.

Technical indicators remain supportive for riskier assets, but they also flag up warnings that conditions are looking frothy. Seasonal factors are positive for equities. But investor sentiment is extremely bullish and fund manager cash levels are at 14-year lows and flows into the market are surging – at some USD180 billion, they’re at record year-to-date levels.

Opinion written by Luca Paolini, Pictet Asset Management’s Chief Strategist.

Discover Pictet Asset Management’s macro and asset allocation views.

Notes:

[1] Bloomberg consensus forecasts for 2021 as at 12.02.2021.

Important notes

Lyxor ETF Plans to Double its ESG Assets and Become a Leader in Climate and Thematic ETFs

| For Beatriz Zúñiga | 0 Comentarios

Foto cedidaArnaud Llinas, responsable de Lyxor ETF e Indexación en Lyxor Asset Management. Lyxor ETF quiere duplicar sus activos ESG y ser líder en ETFs climáticos y temáticos

In 2021, Lyxor ETF plans to accelerate its efforts to expand its range on three key ETF product pillars: ESG and Climate, Thematics and Core. In a press release, the firm explained that this will help meet “the long-term needs of the wealth management segment as ETF usage in Europe expands among individuals and to support its institutional client base”.

To achieve this, the asset manager has made building assets in these three key areas a strategic priority for 2021. As such, it aims to double the ESG ETF assets it had in 2020 to 10 billion euros by the end of 2021. To achieve this, Lyxor ETF plans to expand its ESG offering by switching several of its existing ETFs to equivalent ESG indices, thereby offering a simple alternative to traditional market capitalizations to meet its clients’ needs. Lyxor also continues to implement its program of fund labelling and intends to obtain the “SRI Label” for its entire thirty ESG ETF range by the end of the year. At the end of February, its ESG ETF assets under management totaled 6.5 billion euros.

As a pioneer in passive fund management, last year it became the first ETF provider in the world to launch an extensive ecosystem of ETFs in line with the Paris Agreement and carbon neutrality by 2050. In this sense, the asset manager believes interest in climate indices appears set to grow: “We are already seeing evidence of this in the flows towards regional (notably European and US equities) and global indices from various types of institutional investors (insurers, pension funds, asset managers), in part because of increasingly stringent regulations in Europe”, they said.

This year, Lyxor ETF intends to bolster its range of climate ETFs by extending it to certain fixed income segments and expanding its range of Green Bond ETFs. In total, it now manages close to 1.5 billion euros in climate-focused ETFs.

An enhanced and increased ETF range

Also, it plans to increase its Thematic ETF range to capture new global post-Covid trends. Following the success of its megatrend ETF range last year –over 700 million euros in net new assets collected in less than a year– Lyxor seeks to offer wealth managers in particular more ways to invest in the companies set to benefit from significant and lasting changes in the post-pandemic world. Having launched five Thematic ETFs in partnership with MSCI in 2020 –on Digital Economy, Disruptive Technology, Future Mobility, Smart Cities and consumer habits of Millennials– it is looking to offer investors exposure to rapid innovation in sectors such as healthcare and Clean Tech and in specific geographies.

The firm also wants to further enhance its Core range, which, since it was launched in 2017, has become a cornerstone of the firm’s product offering. In this sense, it has a raft of initiatives planned for 2021, notably within fixed income, where inflation products are key priorities with central banks and governments around the world spending freely to fuel a post pandemic recovery. “This builds on the success of the Lyxor Core ETF on US TIPS, which now totals 3.6 billion euros in AUM after a very strong 2020. Regional and single country allocations are also key areas of interest”, they explained.

In support of its repositioning around these three key pillars, Lyxor also plans to adapt and streamline the rest of its range to ensure it better reflects clients’ long-term investment and savings goals.

“Having started as tactical allocation building blocks for institutional investors, ETFs have since become long-term savings instruments for a much wider range of investors including in the wealth management segment. That is only going to accelerate. Our shift in focus aims at addressing investors’ long-term concerns -aiding the transition to a low-carbon economy, capturing new themes in a post-Covid world and ensuring maximum efficiency for their investments– and as such reflects the profound change in nature of the ETF market”, stated Arnaud Llinas, Head of Lyxor ETFs and Indexing at Lyxor Asset Management.

Market Myopia

| For Fórmate a Fondo | 0 Comentarios

money-4418858_1920 — Pixabay CC0 Public Domain. Un mercado miope

Markets are never at a standstill. However, since bottoming out last year, they have been pretty much on auto-pilot. The reason is simple, the pandemic has been ravaging the economy, but wartime fiscal and monetary stimuli have provided enough oxygen to avoid collapse and buy time until the long-awaited vaccines began to arrive. With them, the countdown to normalization began, but also the return of anxiety to the markets.

In normal times, markets constantly assess the health of the economy by looking at a myriad of macroeconomic indicators; but doing this today is pointless. We are almost certain that, by the summer, a tsunami of pent-up demand will give a once-in-a-century boost to the economy.

The situation is so unusual that it seems impossible to see beyond that point. We are in the early stages of a new economic cycle; one that will start with growth rates not seen in decades, and whose outcome is unpredictable. In a way, we are suffering from macroeconomic myopia.

However, market participants do not give up trying to see what comes next, since investing is, after all, an anticipation game. The most obvious danger that one can conceive of today is an acceleration of inflation; since supply will surely struggle to cope with a surge in demand (this year you better book your holidays well in advance). This is how inflation expectations have taken hold, roiling bond markets and threatening to derail the equity bull market.

This way of thinking is very short-sighted. After the bonfire is lit, we will surely see a red-hot economy, but combustible material will progressively decline as the fiscal stimulus (probably not the monetary one) is phased out. Inflation will go from flames to smoke, and the market will inevitably become concerned about whether the fire can be sustained, or whether it will be extinguished in a recession. Or in other words, the market will go back to its normal calibration mode.

Financial markets are a complex dynamic system with many interrelated variables. It is very hard to grasp how (and to what extent) one variable influences another at any given time, or if causality is reversed. But we are human beings and we try to make sense of it all by compartmentalizing the system and building narratives around the parts.

The current storyline is more or less the following: it is widely accepted that, of all variables, interest rates are the most important; since they are the key to valuing any cash flow-producing asset, from bonds to stocks to real estate. On the other hand, interest rates are a function of inflation, which in turn depends on the growth of the economy.

So far, bond markets seem to be following this train of thought. Plentiful stimulus and consumers with savings in their pockets, implies runaway growth; ergo inflation will accelerate and interest rates will have to rise.

This way of thinking assumes that it is the economy that determines the performance of financial markets. But the reality is much more complex. The direction of causality can quickly be reversed: higher rates can cause asset prices to tumble as well as financing costs to increase, that dents the wealth of households (particularly if it affects real estate prices) and the ability of corporates to borrow, threatening to bring the economy into a recession. The latter, lowers inflation expectations, and with it so decline interest rates; voilà!

The market is a kind of huge voting machine, where its participants constantly calibrate the different probabilities of the manifold variations of these two basic narratives. But the fact is that, after four decades with inflation and interest rates falling, thereby contributing to inflating asset prices, there is now enormous interdependence in the system. Therefore, a sudden big change in interest rates seems almost impossible.

Inflation has dimmed due to a combination of structural factors: demographics, excess debt, globalization and digitization. And the pandemic will only accentuate this trend. The only conceivable way to experience a sustained rise in inflation would be a sharp swing in taxation. One that causes a redistribution of wealth from capital to workers, as happened during the 70s. That episode coincided with another redistribution, from oil-importing countries to oil-exporting ones. It is highly unlikely that something like this will happen again, as the context has radically changed since then.

Communism collapsed spectacularly and globalization took off, thereby evaporating the bargaining power of workers. The market economy has been so dominant that even the Chinese economic miracle is explained by adopting it. No one can seriously argue today that the public sector can be the engine of growth. And when it comes to oil prices, renewable energies bring us ever closer to a scenario of full abundance.

Only very bad policies can drive the system into a higher inflation regime. But the deflationary forces are so strong that we would need much more than gargantuan budget deficits. We would have to see the United States becoming Venezuela. Or just as likely, discover that an asteroid is on a collision route with Earth in a few years, and we set out to spend everything we have.

If the current status-quo holds however, it is almost certain that the economy will keep growing, technology will continue transforming our daily lives, and market forces will prevail over political experiments. In this environment, we think that a combination of quality stocks to capture growth, and US Treasuries to protect us from the occasional recession, are currently the best possible combination.

However, if the current status quo is maintained, the economy will almost certainly continue to grow, technology will continue to transform (and cheapen) our daily lives, and market forces will prevail over political experiments. In this environment, we believe that a combination of quality stocks to capture growth and Treasuries to protect us from the occasional recession is currently the best possible combination.

An article by Fernando de Frutos, Chief Investment Officer at Boreal Capital Management

Emerging Markets Sovereign Bonds: Local or Hard Currency Debt?

| For Magdalena Martínez | 0 Comentarios

Captura de pantalla 2021-03-03 a las 14 — Pixabay CC0 Public Domain. ,,

Colchester believes that local currency EM government debt is particularly attractive today for both strategic asset allocation (in terms of capital preservation, liquidity and return), and tactical reasons (it offers attractive valuations at this juncture). Whilst hard currency EM sovereign debt has historically generated attractive returns, its characteristics are less conducive to the objectives of safety (i.e. capital preservation) and liquidity, given the lower credit ratings and poorer liquidity in this space. In the following analysis, they show that current valuations of the hard currency EM debt asset class are less attractive than those prevailing in local currency space:

Our analysis suggests that the US dollar remains fundamentally overvalued in real terms against many developed and emerging market currencies. The recent relative weakness in the US dollar may be the beginning of a significant depreciation, and if this is the case, historically such a backdrop has been a positive environment for EM assets. Such a depreciation would also benefit non-USD EM assets. With US interest rates depressed, and monetary policy unlikely to shift gears any time soon, the incentive to deploy capital in EM is strong, in the absence of significant negative shocks.

Our stance on the relative attractiveness of EM currencies is further underpinned by the strength of the external position of many economies compared to history. A vulnerability to external shocks and capital outflows has historically been a characteristic of EM economies, but at present we believe that such vulnerabilities are low – at least in the major issuers of local currency EM government debt

In our opinion, local currency EM debt offers structurally higher liquidity and lower credit risk. The diversification benefits are also somewhat better. Global factors tend to have more of an influence on hard currency debt markets while domestic drivers tend to impact more on local currency debt markets. Lastly, the cyclical outlook favours local currency assets given (i) the relative undervaluation of the currency component, as the US dollar remains fundamentally overvalued against most global currencies; and (ii) the accommodative stance of monetary policy in developed markets continues to act as a “push factor” for capital to seek higher returns in emerging markets.

Historical Returns and Correlations

Historically both EM hard and local currency debt (unhedged) have generated meaningfully higher returns than traditional defensive fixed income assets such as US Treasuries, albeit with higher volatility. The local currency asset class has comfortably outperformed US Treasuries, global developed market government debt, and US corporate debt since the inception of the standard index for local currency EM debt at the end of 2002. Hard currency debt has performed even better over this time period, generating similar returns to that of high yield corporate debt. Unhedged local currency EM debt has historically generated more volatile returns than hard currency EM debt. This is a function of exchange rate movements.

Furthermore, the diversification merits offered by local currency EM debt appear to be superior to that offered by hard currency EM debt, given its historically lower correlation to US Treasuries, investment grade corporate, and high yield corporate debt. Hard currency bonds are typically held by global investors and are valued and priced by the market as a credit spread relative to the US Treasury curve (as USD-denominated debt comprises the majority of this asset class). Local currency EM bond markets on the other hand, are typically dominated by domestic investors, and are therefore less sensitive to changes in global financial conditions and more sensitive to domestic economic conditions.

Relative Valuations

Both USD- denominated EM hard currency debt and US corporate debt are priced as a spread relative to US Treasuries. As US Treasury yields are close to historical lows and offering deeply negative real yields at present, and the yield on the standard EM hard currency index is also, not surprisingly, close to its historical lows. It is also questionable whether a nominal yield of around 4.5% sufficiently compensates for the underlying credit risk in the hard currency EM debt asset class.

Hard currency EM debt spreads widened meaningfully in early 2020 but have already retraced most of the maximum deviation from the average credit rating spread, with the “gap” relative to US Treasuries down to a relatively modest 60bps. This needs to be weighed against the increased default risk that has also risen materially over 2020. A number of issuers have already defaulted, and around 5% of the index by market value was trading at distressed levels at the end of 2020 i.e. with spreads of over 1,000bps. This suggests that the apparent attractiveness of the spread should be discounted by this changed default and stressed environment.

A closer look at the spread on the investment grade (BBB- and higher) segment of the index in isolation provides an insight into this effect. Instructively, the current level of spread is below the average of the past five and ten years, and is close to the lows observed in 2012, 2017 and 2019. This suggests that the relatively less risky segment of the index (i.e. with lower probability of default) is currently not offering compelling value. It also suggests that the spread on the index itself is being boosted by the lower-rated more speculative credits – hinting at a case of “spread illusion”.

Similarly, the nominal yield on the index itself, at 4.55% as at 31st December 2020, is somewhat boosted by the high spreads and the higher yields in these more distressed markets. The yield on the investment grade segment, which makes up over 50% of the total index, was only 2.72% as at the end of 2020.

Turning to local currency EM debt, Colchester values local bond markets in terms of their relative prospective real (i.e. inflation adjusted) yield, and currencies in terms of their real exchange rates. The bond element is simply the weighted average prospective real yield. In other words, the nominal yields in each market adjusted for Colchester’s forecast of future inflation. The currency element is the index weighted percentage over- or under-valuation in real terms relative to the US dollar, divided by -5. The over- or under-valuation is estimated by calculating the real exchange rate for the currency and comparing that to a measure of long-term equilibrium or “fair value”.

Combining today’s bond and currency valuations suggests that local currency EM debt is attractively valued compared to history. Whilst not at its widest observed valuation points, the intrinsic real value compares favourably to history.

This is largely due to EM currencies being generally undervalued in real terms today. By Colchester’s estimates the weighted average real exchange rate of the local currency index is 11% undervalued against the US dollar. Whilst currency valuation gains may be the largest potential contributor to potential returns today, potential bond returns are also making a meaningful contribution.

Capital Preservation and Liquidity

Default Probability

Local currency debt has a lower default rate across the board. Intuitively we would have expected this. Sovereign issuers typically have the unique ability to create (“print”) the currency of denomination of the bond, as well as an ability to raise taxes from their domestic economies to meet financing and servicing needs. Governments also face pressure from their local population, who vote, or implicitly have the power to remove those in government. It is therefore not surprising that, as most local currency EM debt is held domestically, there is a greater willingness to default on foreign rather than domestic creditors at a point of stress.

Credit Rating

Given the higher default probability on hard currency EM debt, asset allocators need to be aware of the different rating profiles of both EM fixed income sectors when comparing the two. Not only is the probability of default lower in local currency debt, the credit rating of the standard local currency EM index (JP Morgan GBI-EM Global Diversified) has a demonstrably higher rating profile than its hard currency counterpart (JP Morgan EMBI Global Diversified). The higher credit rating enjoyed by local currency debt is not surprising as economies with more stable currencies and inflation, as well as deeper domestic capital markets, tend to issue more debt in local rather than hard currency. Many of those countries included in the local currency index issue around 90% of their debt in local currency.

Liquidity

Liquidity is the final characteristic asset allocators need to consider. When we compare the depth and liquidity of each market, we observe that the local currency universe is significantly larger and more liquid. Currently, the market value of EM local currency government debt is estimated by the Institute of International Finance, to be around USD 14 trn, whereas the stock of hard currency debt is estimated at only USD 1.3 trn. This large and widening discrepancy is not surprising, as countries have an incentive to reduce their external vulnerability by developing local capital markets and issuing in domestic currency. This reduces their exposure to external shocks, a flight of capital, and a potential shortage of foreign currency to meet funding needs. The three largest issuers of government debt within the EM universe – China, India and Brazil – each issue more than 90% of their government’s debt in local currency.

The depth and liquidity of the local currency EM government bond universe has been significantly enhanced by the opening of the Chinese local bond market to foreign investors in recent years. Local Chinese renminbi (yuan) denominated government bonds offer liquidity (the market is over USD 7 trn in size), a relatively high credit rating, and a negative correlation to risk assets.

Additionally, the opening of the domestic Indian government bond market to foreign investors is also accelerating. It too offers lower correlations with other global bond markets and asset prices. India is expected to be admitted to various EM bond indices in the not too distant future, further enhancing potential return and diversification characteristics of the local currency EM debt asset class.

This article should not be relied on as investment advice. Colchester Global Investors Limited is regulated by the UK Financial Conduct Authority, and only deals with professional clients. https://www.colchesterglobal.com for more information and disclaimers.

Insigneo Moves its Headquarter Offices into a Penthouse in Brickell Avenue

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Insigneo is officially moving its headquarter offices to reside in the penthouse of 1221 Brickell Avenue (Miami), “right in the heart of Brickell’s fast-growing financial district”, revealed the company through a post on its LinkedIn. The building will bear its name and new logo.

“Along with the multitude of incredible companies making their transition to Miami, we’re ever so proud to still call this location our home”, commented the independent investment advisory firm in its publication, which referred to a Business Wire article.

The offices will occupy the penthouse of the class-A building and the floor below it, representing a total of 27,047 square feet. The expanded office space, designed by G. Alvarez Studio, focuses on transparency and community, and will allow the company to support its continued growth into the future, the article said.

While Insigneo prepares to begin utilizing the space later in the fall, their LCD signage is expected to rise to the top of the building this summer. In the meantime, their 70 full-time employees will continue to use their current offices at 777 Brickell Avenue; as the company is currently operating under a hybrid work model, with only 50% of employees in the office at the same time and many of them working from home.

“We are very excited about our future home as it represents the beginning of the next chapter in our company’s history. Our city continues to attract top talent in our field and continues to grow in importance as a Global financial center. We believe that being headquartered in Miami is a big advantage when it comes to our goal of being the first tech-enabled Pan-American Wealth Management platform” pointed out Daniel de Ontañon, Chief Executive Officer for Insigneo.

The operation takes place while Insigneo continues to grow its advisor network in its goal to position itself as “the true alternative” for top US Financial Advisors with Global practices.

Morgan Stanley Closes the Acquisition of Eaton Vance

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1519796500693 — Foto cedida. Morgan Stanley completa la compra de Eaton Vance

Morgan Stanley has completed this week the acquisition of Eaton Vance, a stock and cash transaction announced last August for an equity value of approximately 7 billion dollars.

In a press release, the firm revealed that Eaton Vance common stockholders were offered 0.5833 Morgan Stanley common shares and 28.25 dollars per share in cash for each Eaton Vance common share, and had the opportunity to elect to receive the merger consideration all in cash or all in stock, subject to proration and adjustment. As provided under the merger agreement, Eaton Vance shareholders also received a special dividend of 4.25 dollars per share, which was paid last December 18 to shareholders of record on December 4.

“This acquisition further advances our strategic transformation by continuing to add more fee-based revenues to complement our world-class, integrated investment bank. With the addition of Eaton Vance, Morgan Stanley will oversee 5.4 trillion dollars of client assets across its Wealth Management and Investment Management segments. The Morgan Stanley Investment Management and Eaton Vance businesses are delivering strong growth and their complementary investment and distribution capabilities will deliver significant incremental value to our investment management clients,” said James P. Gorman, Chairman and Chief Executive Officer of the company.

Thomas E. Faust, Chairman and Chief Executive Officer of Eaton Vance, will become Chairman of Morgan Stanley Investment Management and will join the Morgan Stanley Management Committee. “We are pleased to join Morgan Stanley to begin the work of building the world’s premier asset management organization. On a combined basis, Morgan Stanley Investment Management and Eaton Vance have unrivaled investment capabilities, distribution reach and client relationships around the globe“, he commented.

Lastly, Dan Simkowitz, Head of Morgan Stanley Investment Management, claimed to be excited to welcome Eaton Vance: “Our combined organization is exceptionally well positioned to deliver differentiated value to our clients and growth opportunities for our employees”.

Mediolanum International Funds Seeds New Equity Mandates for SGA and NZS Capital

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cake-pops-684163_1920 — Pixabay CC0 Public Domain. Mediolanum International Funds otorga a SGA y NZS Capital sendos mandatos de renta variable

Mediolanum International Funds (MIFL) has announced two new equity mandates with SGA and NZS Capital as the firm looks to expand its footprint with boutiques in the United States.

In a press release, the European asset management platform revealed that the agreement with SGA, a Connecticut based independent investment boutique, will see MIFL providing capital of 80 million to seed the SGA Emerging Markets equity strategy, which adopts the same investment approach that made the firm known for the quality of their flagship global equity strategy. The initial investment is expected to grow over the next 5 years.

“We are very excited to work with Mediolanum International Funds and offer our Emerging Market Growth portfolio to European investors at a time when many are seeking EM exposure in a bid to participate in the wealth creation of growing middle classes. This partnership will give us privileged and timely access to European distribution across different countries through MIFL’s local ties to distribution networks in Italy and Spain, and strong partnerships in Germany within the IFA business”, Rob Rohn, Founding Principal at SGA, commented.

MIFL will also back NZS Capital’s Technology strategy, with a 300 million euros mandate. Based in Denver, the investment boutique has a unique philosophy known as Complex Investing which identifies companies that best adapt to unpredictable outcomes. It is minority owned by Jupiter Asset Management which acts as the firm’s exclusive global distribution partner and introduced MIFL to the investment opportunity.

Brinton Johns, Co-Founder of NZS Capital, said that partnering with Mediolanum International Funds is a great step in the firm’s evolution: “This Sub advisory mandate offers European clients access to a portfolio of companies that we believe is best equipped to handle the accelerating pace of change in the global economy. The focus on innovation and disruption is a long-term trend an investment perspective, and one that is especially relevant in today’s environment”.

A 5-year plan

MIFL highlighted that its multi manager approach, which combines funds and mandates, is the engine of several mutual funds and customised investment solutions and services for insurance products and banking services distributed across Italy, Spain, and Germany. “We are delighted to have both SGA and NZS Capital LLC on board. Both managers have proven to generate great value over the time for their investors and by partnering with them in these new strategies we expect our clients to benefit as well”, pointed out Furio Pietribiasi, CEO of the platform.

He also revealed that their objective in the next 5 years is to invest at least one third of all their equity and fixed income assets externally managed in partnership with boutiques with strong track record by seeding new strategies or investing in existing ones. In his view, the evolution of the industry globally is offering “a unique opportunity” and they believe they are well positioned to take advantage due to their entrepreneurial culture and 23 years plus experience in multi management.

“We are looking to collaborate with boutiques where we can add value to their overall business. We think that the AUM in breadth of strategies we have, plus our flexibility and unique entrepreneurial culture is fundamental to success We already have a proven track record in helping start-ups or small asset managers to grow, it is now time to scale it up”, he concluded.

PIMCO Names Giovanni Onate Senior Vice President and Kimberley Stafford Global Head of the Product Strategy Group

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PIMCO_Stafford_Kim_770x340 — Foto cedidaKimberley Stafford, nueva directora global del Grupo de Estrategia de Producto de PIMCO.. PIMCO nombra a Kimberley Stafford directora global del Grupo de Estrategia de Producto y a Alec Kersman director de Asia-Pacífico

In the last few days, PIMCO has announced numerous changes in its executive positions. As it confirmed this week to Funds Society, Giovanni Onate will be joining them in Miami in the position of Senior Vice President. Also, in a press release, the asset manager revealed that Kimberley Stafford, currently Head of Asia-Pacific, will become Global Head of its Product Strategy Group.

Onate will be leading business development efforts in Mexico as the firm continues to expand its presence in Latin America and the Caribbean. He will report directly to Barbara Clancy, Executive Vice President and Head of Latin America and the Caribbean for PIMCO. Onate had been leading BlackRock’s Mexico institutional client business for more than a decade and will now be replaced by Horacio Gil, who joined the firm in 2019.

Stafford will return to PIMCO’s Newport Beach office in the middle of this year to take up the new role, overseeing traditional strategies and alternatives, which include PIMCO’s private strategies and hedge funds. Consequently, Alec Kersman, currently Head of Strategic Accounts in U.S. Global Wealth Management, will become the new Head of Asia-Pacific. Both will report to Emmanuel Roman, Managing Director and PIMCO’s Chief Executive Officer.

Stafford has been a member of PIMCO’s Executive Committee for five years and will also serve as a Trustee on the Board of PIMCO Funds, alongside Peter Strelow, Co-Chief Operating Officer and Chairman of PIMCO Funds. Stafford has led the Asia-Pacific region since 2017 and, during her 21 years at the asset manager, she has held various positions including Head of the Consultant Relations Group, oversight of U.S. institutional sales and alternatives marketing teams, Head of Human Resources and Talent Management and Head of Global Sustainability Initiatives and Account Manager in the Consultant Relations Group.

“Kim has served in almost every facet of our business during her two decades working for PIMCO. She is a strategic thinker and a natural leader who motivates, mentors and develops employees. Her expertise in managing client relationships will be invaluable as we continue to evolve our products and strategies for investors in traditional and private strategies”, said Roman.

Regarding Kersman, the firm highlights that he drove the growth of the Latin America business over more than a decade and, more recently, has played a major role in bringing his client relationship expertise to U.S. GWM: “With his deep understanding of the regulatory environment and proven strategic leadership, Alec will build on the excellent work that Kim and the team have delivered over the past four years driving our expansion in Asia-Pacific,” added Roman.

Kersman will be supported in Asia-Pacific by PIMCO’s regional leadership team and deep bench of investment professionals. In addition, John Studzinski, Vice Chairman of PIMCO’s Executive Office, will continue playing a key role in broadening relationships in Asia-Pacific with leaders in business, finance, government and NGOs.

Other appointments

The firm also announced other key leadership roles: David Fisher, currently Head of Traditional Product Strategies, will become Co-Head of U.S. GWM Strategic Accounts alongside Eric Sutherland, President of PIMCO Investments LLC. Fisher, who has spent 13 years as a leader in the Product Strategy Group and also serves as a trustee of PIMCO Closed End Funds, will relocate to the New York office. He and Sutherland will report to Gregory Hall, Head of U.S. GWM. Ryan Korinke, Head of Hedge Fund and Quantitative Strategies, based in Hong Kong, will join PIMCO’s Executive Office in Newport Beach, where he will report to Roman.

Commenting on Korinke’s role in the Executive Office, Roman pointed out that his understanding of hedge fund strategies and the role they play for clients, together with his “detail-oriented and thoughtful approach” have helped deepen many of their relationships with hedge fund investors around the world. “He is a creative and analytical thinker and widely admired by PIMCO colleagues as an executive who embodies PIMCO’s culture”, he concluded.

Standard Life Aberdeen Simplifies and Extends its Strategic Partnership With Phoenix Group

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Foto cedidaStephen Bird, director general de Standard Life Aberdeen.. Standard Life Aberdeen cambia su nombre a Abrdn

A few weeks ago, there were rumors that Standard Life Aberdeen might change its name after selling its brand to Phoenix Group. Finally, this week the asset manager announced in a statement that it has decided to simplify and expand its partnership with Phoenix Group, shedding light on the future of its brand.

This strategic partnership started in 2018, when Standard Life Aberdeen sold its UK and European life insurance business to Phoenix Group for 3.24 billion pounds. The transaction created a complex network of commercial and operational services between the groups, including the shared use of the “Standard Life” brand.

The agreements announced this week simplify the partnership focusing it on the provision of Standard Life Aberdeen’s high-quality asset management services to Phoenix Group and its insurance and workplace pension customers.

Now, the strategic asset management partnership, under which Standard Life Aberdeen currently manages 147.4 billion pounds of Phoenix Group assets, will be extended until at least 2031 (in the original agreement, it was up to 2028). Also, the asset manager will pay upfront 62.5 million pounds for the purchase of the Wrap SIPP, onshore bond and TIP businesses from Phoenix, which represent 36 billion pounds in assets under management.

The agreement also establishes that Standard Life Aberdeen will pay 32 million pounds to Phoenix Group for bearing the cost of some transferring colleagues going forward after selling its brand and will no longer provide marketing services. Lastly, the resolution of legacy matters will not materially impact on Standard Life Aberdeen’s 2020 financial performance, as it will receive a net cash inflow of 34 million pounds this February.

Standard Life Aberdeen will sell its brand to Phoenix Group during the course of 2021, a transaction that they don’t expect to impact materially on their results. The asset manager also revealed that it has initiated a branding review, the outcome of which it will announce later this year.

A recognized brand

“The most successful partnerships in business tend to be formed on clear and simple terms. What we are announcing today is an agreement that simplifies the relationships between Standard Life Aberdeen and our strategic partner Phoenix Group in a way that will allow us to work together constructively as partners for at least the next ten years. Both businesses will be able to play to their respective strengths in the partnership”, said Stephen Bird, CEO of Standard Life Aberdeen.

He also pointed out that the “Standard Life” brand has an important heritage: “In the UK, it has strong recognition as a life insurance and workplace pensions brand. This is closely aligned with Phoenix’s strategy and customer base. This is much less the case with the business we are building at Standard Life Aberdeen which is focused on global asset management, our market-leading platforms offerings to UK financial advisers and their customers, and our UK savings and wealth businesses. That’s why I am excited about the work we are doing on our own brand, which we look forward to sharing later this year”.

Lastly, Andy Briggs, CEO of Phoenix Group, claimed to be delighted with the extension of the strategic asset management partnership until at least 2031: “This recognizes the global expertise and excellent service that Aberdeen Standard Investments delivers to Phoenix Group and our customers as our preferred asset management partner. The simplification of the Standard Life brand, sales and marketing will be a key enabler of Phoenix’s growth strategy, which in turn should lead to greater asset flows to ASI.”