Emerging market credit in 2017: external events to outweigh country specifics

25/11/2016

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Steve Drew, Head of Emerging Market Credit, talks about the unprecedented flows into the asset class in 2016 and why he believes, apart from the obvious political developments, other themes in 2017 are likely to broadly reflect those of this year.

What lessons have you learned from 2016?
Emerging market fundamentals have been fairly benign since the start of the year when political risk in Brazil was diffused by the impeachment process. 2016 revealed that the direction of emerging market corporate bond markets can be driven as much by external events as internal. The strong returns from February to September were unexpected and driven by unprecedented levels of central bank intervention, while the search for yield in turn prompted unprecedented flows into the asset class.

What are the key themes likely to shape the markets in which you invest in 2017?
It is too early to say if we are now entering a ‘taper tantrum’ type scenario as in 2013. Many parallels between now and then have been drawn, but so far the sell-off feels orderly. Yes, emerging market bonds have experienced large outflows since Trump became the US President-elect, but these pale into insignificance when compared to the size of the inflows year-to-date. So far this year, inflows into emerging market hard currency funds now stand at $39bn.

Away from the obvious political developments, other themes are likely to remain little changed compared to 2016. At a micro level, many companies have spent the last two years managing their liabilities, which means that most refinancing needs have already been met. This is likely to keep a lid on net supply in 2017. Regional themes are also expected to remain a constant. For example, in Asia 95% of new issues will continue to be bought by local accounts, with Chinese investment grade bonds still dominating new issuance.

We do not expect to see a pick up in defaults. Emerging market defaults are already running at a lower rate than in developed markets. The pick up in defaults earlier in 2016 was mostly driven by Latin American oil and gas credits, and as with US high yield energy companies, those credits that needed to default have mostly done so now.

We expect to see continued issuance from sovereigns in 2017, in particular out of the Middle East. The budget deficits of these oil-dependent economies are likely to make them frequent issuers in the debt capital markets in a way that they have not been in the past, since the oil price appears to be entrenched in the $40-50 per barrel range.

What are your highest conviction positions moving towards the new year?
Our highest conviction trades moving into the new year are those positions that are as much as possible uncorrelated to the broader market direction. By this we mean:

  • Secular growth stories: such as IHS, a Nigerian towers business, which is well-positioned for growth in mobile penetration rates and has little to no link to commodity prices or interest rates.
  • Least volatile issues from higher quality companies: such as short-dated Petrobras bonds.
  • Defensive plays: such as Chinese investment grade names in companies, which either have explicit government support or implicitly are likely to be deemed ‘too big to fail’.
  • Sovereign issuers, which offer compelling value.
The portfolios will also continue to focus on the more liquid issuers.

What should investors expect from your asset class and your portfolio going forward?
Emerging market bonds will continue to be dominated by external rather than emerging market specific events. We do not see any one country, sector or company likely to derail emerging markets, unlike Brazil this time last year. There are, however, plenty of external events on the horizon to shape our thoughts going forward, starting with the US Federal Reserve (Fed)’s meeting in December. We expect the Fed to hike interest rates by 25 basis points but to maintain a dovish tone and allow for 1-2 rate hikes next year. A dovish Fed statement should be sufficient to set the tone for a ‘carry’ year for emerging market corporate bonds, although with a decent tail risk on either side.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

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Important information

Please read the following important information regarding funds related to this article.

Janus Henderson Horizon Emerging Market Corporate Bond Fund

Specific risks

  • This fund is designed to be used only as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • The value of a bond or money market instrument may fall if the financial health of the issuer weakens, or the market believes it may weaken. This risk is greater the lower the credit quality of the bond.
  • Emerging markets are less established and more prone to political events than developed markets. This can mean both higher volatility and a greater risk of loss to the Fund than investing in more developed markets.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Any security could become hard to value or to sell at a desired time and price, increasing the risk of investment losses.

Risk rating

Janus Henderson Horizon Total Return Bond Fund

Specific risks

  • This fund is designed to be used only as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • The value of a bond or money market instrument may fall if the financial health of the issuer weakens, or the market believes it may weaken. This risk is greater the lower the credit quality of the bond.
  • Emerging markets are less established and more prone to political events than developed markets. This can mean both higher volatility and a greater risk of loss to the Fund than investing in more developed markets.
  • Changes in currency exchange rates may cause the value of your investment and any income from it to rise or fall.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Any security could become hard to value or to sell at a desired time and price, increasing the risk of investment losses.
  • Callable debt securities (securities whose issuers have the right to pay off the security’s principal before the maturity date), such as ABS or MBS, can be impacted from prepayment or extension of maturity. The value of your investment may fall as a result.

Risk rating

Janus Henderson Institutional High Alpha Credit Fund

Specific risks

  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • If the Fund holds assets in currencies other than the base currency of the Fund or you invest in a share class of a different currency to the Fund (unless 'hedged'), the value of your investment may be impacted by changes in exchange rates.
  • The Fund invests in high yield (non-investment grade) bonds and while these generally offer higher rates of interest than investment grade bonds, they are more speculative and more sensitive to adverse changes in market conditions.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.

Risk rating

Janus Henderson Institutional High Alpha Gilt Fund

Specific risks

  • If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.

Risk rating

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