Sergei Strigo, of Amundi, speaks about Emerging Market debt, currency, and credit risk

.>>SERGEI STRIGO: Very briefly, history of their asset class in emerging market debt has moved,
the oldest asset class is external debt.
So for the past 20 to 30 years ago, countries could only borrow in US dollars.
And that, the risk of this asset class is measured by the spread
versus the respective underlying treasury security, for example.
If you have a bond issued in Mexico in US dollars, for example,
the respective benchmark would be US treasuries in dollars.
So how we evaluate whether it’s cheaper or expensive,
we look at the spread of Mexican bond versus the treasuries.
Foreign exchange has been newer asset class.
Obviously, a lot of foreign exchange is still non-deliverable.
The countries have capital control but it’s a rapidly developing asset class.
It would be, I think, very exciting.
And the local debt is the newest asset class.
As macroeconomic fundamentals over the countries have improved,
the countries started to issue more debt in local currency.
That way they take out the foreign exchange risk completely.
At the end of the day, countries can always print more local currency.
Let’s face it, this is what we are doing in the Euro zone, in the US and repay the debt.
So there is no foreign exchange risk.
There is no risk of run on the FX reserves, et cetera.
This is the asset class where we see the most interest currently
because the yields are attractive and macroeconomic fundamentals are pretty solid.
These are some of the charts that serve as models we use to look at macro factors.
You can see there’s a spider graph or roughly
we’ll analyze many macroeconomic fundamentals.
On the right hand side, it’s a credit report.
As I said earlier, every corporate position, every corporate bond that we buy,
we have a view on the company and is followed by one of the analyst.
And this is an example of the credit report that we have on a monthly basis.
Some of the technical models as well express the fundamentals,
where we look at the rating per country and the spread; the way it is trading.
We look at the relative value analysis versus the benchmark and the spread momentum.
Again, this is some of the things we look at
and then it will help us to take a view on a specific country or a specific part of the curve.
This is some of the foreign exchange models we run.
The real effective exchange rate CPI based;
for example in this case, it’s the Korean won.
We also look at the yield curve, the shape of the yield curve
whether it is stiff or flat depending on that,
we choose on which part of the curve we wanted to be positioned in.
And some of the views, I mean, I think Gavin and Paul already touched upon most of it really.
I mean being a fund manager of emerging market debt, I’m naturally biased.
And I like the asset class. I think we have very decent returns going forward.
You can see that apart from gold, emerging market indices
have been the best performers year to date.
The top one you see, this is the current currency debt.
And there is corporate local currency and foreign exchange as well.
Why do we think the emerging market debt is a good place to be invested currently?
And there are few reasons, first of all it’s a supportive environment for emerging market debt overall.
Another thing that a lot of global interest rates mostly in G3 are going to stay low for awhile,
at least for another year or maybe until 18 months.
So hence you have to have carrying your portfolio, you have to be able to extract returns.
We have to be able to get paid on your capital.
There’s no point being invested in US dollars cash because they get paid zero on that.
Equally but I don’t think there’s a high probability of a double-dip scenario in the US,
which will be obviously negative for global markets.
We think that that QE that we’re going to get this week out of the United States
basically the Federal Reserve will do unlimited QE policy, if they have to do it.
So the probability of double-dip is fairly low currently.
Structural improvements in fundamentals is another very good reason as Gavin pointed out earlier.
I have some charts later on, balance sheets in a much better shape in emerging market countries.
Growth is much, much better than in G3 or developed countries as well.
We also think that valuations are currently attractive in all three asset classes
on the corporate side, on the local side, and also on the external debt side.
And the technical picture is very supportive as well.
Year-to-date in emerging market debt, we had over $50 billion USD inflow
which has surpassed the previous few years.
And we could forecast that by the end of the year,
this flow will probably be close to $75 billion.
So, and we think that the potential for inflows going forward to increase and be high is still there.
All emerging market indices are currently, the average rating is investment grade,
which is another reason why we think that sticky money,
for example US pension funds and insurance companies that are benchmarked
and there is management models of this institutional investors are very strict.
So, if it’s investment grade, these people can invest.
And we think this is where the next wave or wall of money, so they say, will come into the asset class.
Public debt to GDP ratios are better in pretty much any emerging market country.
You can see here comparing to advanced economies, it’s a divergent graph;
under 40% in EM versus 100% and rising in the developed universe.
Similar chart. What Gavin will say just along the lines that, for example,
countries like Japan, United States, or some of the <> Europe are in trouble.
I mean the debt to GDP ratios are well over 100%
comparing to the emerging market countries on the right hand side
we say that very, very manageable debt levels altogether,
both on the private and public side.
In growth, very robust.
This year, we forecast on average roughly 7% growth of GDP in EM.
Next year probably, they’re going to be about 6% in 2009.
Emerging markets on average did not have a recession, comparing to countries in the developed world.
G3 growth this year and next year will be around 2%.
So, we have at least 4 to 5 percentage points difference in GDP growth
And these are the charts showing that, you can see, why the situation in growth is better
because most of EM countries didn’t have a banking crisis.
Consumers are not leveraged.
There is very low mortgage penetration on average.
So, there is no crisis in terms of real estate or anything like that.
There was no sharp rise in unemployment.
No exit strategy dilemma like what we’re faced with in the Eurozone or in the US or Japan.
And for the first time in many years, for the first time ever actually,
emerging markets were able to run countercyclical monetary policy, which was very, very effective.
Hence, they manage to come out of the crisis in a much better shape
than people would have thought that they would.
And now the interesting thing is that the composition of trade with emerging markets is changing.
I mean, we’re all used to think of EM as that it’s the countries with the low wages,
that they produce very cheap goods and export it
to the developed world to the US, to Japan, to Eurozone.
Well, if you look at this chart you can see that the exports of emerging market countries
to other emerging market countries like China is increasing,
which means that or you’re taking out the risk of slow growth in the US
impacting the emerging market more which is quite interesting fact.
The same similar thing with South Korea.
Private capital flows into EM are picking up.
There are also FDIs, very large reserves, extremely high level.
I think the total level of reserves in emerging market central banks is close to $6 trillion.
Valuation wise, as I said earlier, I would think that valuation is attractive.
As you can see, comparing to US dollars cash, indices like global aggregate, the US high yield.
We are a very, very high-yielding asset class,
quote between 5% and 6%, either on external debt or on local currency debt.
And the inflow story, as I said earlier, over $50 billion inflow year to date.
We think that it will go to probably $75 billion.
We think that the asset class is largely underowned
because it has always been perceived as a very risky proposition.
Well, I think this will change going forward.
As I said earlier, OECD pension funds have roughly $16 trillion under management.
The proportion of emerging market debt in their portfolio is negligible.
So even if they put a small percentage allocation,
let’s say less than 5% of their funds and into emerging market debt,
it will be a huge inflow into the asset class.
This year we also see strategic inflows from sovereign wealth funds from reserve management.
Central Banks of emerging market countries are buying each other’s debt
because they don’t want to be stuck with US treasuries in their portfolios.
They would rather own Brazilian bonds.
They would rather own Korean bonds,
with their much more solid market economic fundamentals story.
So, being bullish on the asset class, some of our views we overweight external debt.
We favor high-yielding instruments, high-yielding countries.
We also like the long end of the local currency curves.
We think this is where the yield is.
And we also like the foreign exchange.
We think that there’s potential for,
great potential for appreciation in the next one year to 18 months.
And we’re running a long exposure to foreign exchange
currently against the basket of Euro’s, US dollars, and Japanese yen;
all free currencies obviously with extremely low yield.
So we are able to extract the most carry on our positions.
So that’s it for me, thank you very much.