Pandemic, policy, pricing and portfolios
Market dislocations can lead to compelling opportunities. Read our outlook for global debt.
When it comes to investing in emerging market (EM) local debt, we seek to maximise potential returns from market exposure to attractive yield and income opportunities that go hand in hand with the relatively higher risks of this asset class.
Concurrently, we believe in harnessing manager skill to minimise downside potential, even at the opportunity cost of avoiding certain trades that could result in above-market returns.
A portfolio’s tracking error is an inadequate measure of volatility, because it gives equal treatment to the positive and negative differences between a portfolio and its benchmark.
We believe that locally denominated debt securities in EM expose investors to a variety of risks driven by foreign exchange, credit quality, interest rates, macroeconomic conditions, and regional politics.
This unique combination of risks, in our view, warrants special emphasis on limiting the downside potential - one that requires manager skill - while wringing value from market exposure to attractive yields and income.
Our proposed strategy for affording investors a smoother ride throughout EM cycles is to incorporate an element of capital loss mitigation during downturns:
We propose a multi-part framework for riding out EM gyrations and achieving above-market annualised returns over the long haul:
Once we identify specific opportunities, we conduct bottom-up security selection that matches our top-down risk budget.
Note that, in our view, bottom-up considerations should be subservient to our overarching risk budget, and thus we make security-level adjustments until they conform to the top-down budget we determined.
The risk/reward nature of locally denominated debt in EM is idiosyncratic - the result of a complex interplay of multiple factors, including foreign exchange, credit quality, interest rates, macroeconomic conditions, and regional politics.
We believe investing in them requires a more nuanced view of risk management and the ways in which manager skill can be harnessed to benefit investors.