eMTA’s Annual Winter Forum was held in
London on Tuesday February 28, 2006. JP Morgan hosted the event, which drew over
150 attendees, in the landmark Great Hall building on the River Thames.
In his introductory remarks, EMTA Co-Chair Mark Coombs (Ashmore Investment
Management) reminded attendees of recent EMTA accomplishments and urged those in
the audience who had not yet become EMTA members to consider becoming part of
the trade association. He also recommended that, with the continued strength in
the markets, those firms currently recruiting new employees take advantage of EMTA’s Job Opportunities website page.
Joyce Chang (JP Morgan) projected a slide of key economic forecasts in
initiating a panel of sell side experts. Chang joked that her colleagues might
have to revise their predictions on 2006 returns, supplied only days earlier, as
a result of late-breaking announcements by several EM sovereigns of early
redemptions and debt buybacks. Chang noted that when she moderated the EMTA
Annual Meeting sell side panel two months earlier, her own firm had produced the
most aggressive EMBI+ forecast at 250; in comparison, Winter Forum panelist
estimates now ranged between 170 and 200. Chang contrasted current EMBI+ levels
with forecasts made at the 2005 Winter Forum, when the consensus view was that
the EMBI+ would be at 350 a year later.
Panel Upbeat on Inflows into EM Debt
chang polled sell side panelists for
their thoughts on the sources of asset class inflows, how the inflows will be
allocated, and what the prognosis is for sovereign debt given the flurry of
buyback announcements. BCP’s Walter Molano opined that global investors
now recognize the ascendance of China and India, with resulting increase in
demand for raw commodities; this has led to increased inflows into Emerging
Market commodity-producers from Asian and more conservative investors. Molano
speculated that the industry would move gradually to a Euroclear-able local
instrument market.
Kaspar Bartholdy (CSFB) described the asset class’ newfound “acceptability,”
with inflows from large G-7 pension funds, as well as EM and G-7 Central Banks
that no longer see the asset class as exotic. Addressing concerns that there
could be a rotation of funds flowing out of debt and into equities, “it is clear
that there are individual funds that are doing that, and in particular some of
the hedge funds have been doing that for a while, but in aggregate, we are
seeing massive inflows into EM debt and EM equity, and that is likely to
continue throughout this year,” Bartholdy affirmed. Tim Ash (Bear Stearns)
stressed that as the Emerging Market debt industry becomes more centered on
local markets and corporate bonds, there is a more pronounced need for corporate
credit research.
Deutsche Bank’s Marc Balston noted that increased demand from buyers such as
Asian central banks and Japan Post, combined with sovereign buybacks and the
limited amount of outstanding debt, all created a demand-supply imbalance. Balston believes that it is hard to determine whether there is a reallocation
between EM debt and equity because both are receiving massive amounts of new
inflows, and both continue to benefit from positive publicity. A small potential
risk is that negative developments in EM equities could carry over into debt, he
noted. Balston concurred with Molano that the increased role of local markets,
and the move away from a benchmark-centered external debt market, would lead to
decreased correlation.
Chang noted that current inflows were the most diversified in recent memory. Asian retail, Asian central bank, Middle East petrodollars, and US pension funds
(now free to invest in non-investment grade instruments in the wake of the US
auto sector downgrades) are serving as the sources of new inflows, with these
new investors much less sensitive to US Treasury movements.
Complacency Debated
turning to a discussion of global
liquidity, Chang asked analysts to discuss how an end to “easy money” could
affect the EM industry, and if the market had become too complacent in not
fearing the possible ramifications. Chang also solicited panelist opinions on
what geopolitical risks could derail EM momentum.
Ash argued that EM fundamentals have improved dramatically over recent years and
their vulnerability to US rates has decreased as a result. “The key risk remains
growth—that the US economy slows and that would have a big impact on Latin
America, but we are generally bullish on G-3 growth,” he affirmed. Ash
acknowledged that risk factors such as avian flu and terrorism were hard to
quantify, but noted that the tourism industries of Turkey and North African
countries had proven “remarkably resilient” following terrorist incidents,
adding that terrorism was no longer viewed as the exclusive preserve of
‘unstable Third World countries.’”
Bartholdy speculated that only a “very sharp slowdown in the global economy or a
serious pickup in inflation risk would throw us off course in Emerging Markets
debt.” For Bartholdy, the asset class’s greatest vulnerability is an event which
drives up oil pricing substantially and affects global growth, and in his view
the most likely cause of such a spike would be military intervention related to
Iran’s nuclear research program.
Balston agreed that only a “massive change” in the global environment or
dramatic change in oil supply could throw the asset class off track. Avian flu
could be contained regionally and have substantial implications on that area,
most likely to be in the emerging world; or it could be on a global scale and
harm global growth, thus also hurting EM economies.
Molano speculated that liquidity would remain high for a long period of time. He
added that with the rise of the Chinese economy, the yuan could become the new
international reserve currency. As the yuan is not fully convertible but is
pegged to the dollar, many of China’s trading partners are holding dollars in
its stead; once the yuan is freely floated and convertible, there will be a
dramatic change in liquidity. However as the Chinese do not currently want to
accept such leadership, the status quo will persist for some time. For Molano,
anti-globalization forces in the G-7 are a greater immediate concern; if the US
and European countries took steps to stop the globalization process, it would
prove the “death knell for EMs.”
Chang also expressed concern about US protectionist sentiments. She noted that
dramatic effect of SAARS on the Chinese GDP growth and refused to rule out the
possibility that avian flu could also cause substantial harm in the emerging
world.
Panel Reviews Turkey, Hungary and Latin Election Cycle
the
panel also addressed political and economic factors in the major EMEA economies. Bartholdy commented that, from a long-term perspective, Turkish policymakers
should probably be concerned by the strength of the lira. However from a
short-term investor perspective, the recent build-up in FX reserves at the
Central Bank could lead to a debt buy-back and “abstaining from international
issuance.”
“There has been a shift in emphasis on Turkey,” added Balston. “We used to worry
about their fiscal position and their ability to pay the debt; now we have moved
positively to worrying about structural issues and economy-wide issues, and this
shows what progress Turkey has made.” Ash emphasized the country’s robust export
growth and large inflows of foreign direct investment, which he believes are
better attributed to the country’s fundamentals than to a bet on its EU
accession prospects.
Balston was skeptical about the prospects for
fiscal reforms in Hungary, stating “there seems be no appetite from the likely
winners of the upcoming elections to implement any reforms.” He also speculated
that the country’s credit ratings could be lowered.
Chang also asked panelists to discuss upcoming Latin elections. Most panelists
opined that regardless of who proved victorious, no major policy U-turns would
result, although optimism for future reforms under incoming governments was
notably muted. Ash pointed out that his team was “relatively sanguine” about a Humala presidency in Peru, noting that the candidate’s economic policy advisor
had worked to develop the domestic yield curve under Pedro Pablo Kuczynski. Bartholdy countered that it was still an open question whether the advisor would
really be part of a Humala government.
Based on their comments during the discussion, panelist recommendations were of
little surprise. Molano and Bartholdy concurred that Argentine GDP warrants were
an attractive investment, with Molano recommending that investors avoid shorting
in general.
Ash spoke positively on Turkey, Bosnia and Serbia while Balston conceded he was
being “dull” by selecting Hungary as an asset to avoid. Bartholdy urged
investors to think twice about some Middle Eastern credits, including Iraq, in
light of concern over military intervention in Iran.
Investor Panel Confident in “Sticky,” “Quality” Inflows
brent
Diment of Aberdeen Asset Management moderated the event’s second panel of
leading investors. Diment got things rolling by noting that inflows into the
asset class were an important driver of recent performance. He asked the panel
to enlighten the audience on the sources of these flows, and what new investors
are expecting in terms of returns.
John Carlson (Fidelity Investments) replied that while he’s seeing a lot of
inflows, from a broad geographic range, there’s been at least one substantive
change over the last couple of years. “The investors giving us money now are
investment-grade focused, so they are looking at the asset class with a
different set of eyes and a different set of objectives than, historically,
people like myself have,” he commented. Carlson added, “We’ve looked at it
with equity-like returns, equity-like volatility; the new investors come in with
the expectation that the story that’s played out over the last 10 years is going
to continue.” But Carlson believes the new investors will stay in this market
because the credits seem inexpensive to them, in contrast to managers with
15-year hindsight who deem them expensive.
Simon Treacher of BlueBay Asset Management concurred that recent inflows involve
“sticky” money from “quality” accounts. “We’re in a position now where
it’s easy to attract hedge fund money, so we can effectively turn that down and
focus more on the long-only portfolios,” he stated. Treacher noted that the development of
the new JP Morgan local markets index has also boosted inflows into the asset
class.
Ashmore Investment Management’s Jerome Booth also stressed the “stickiness” of
new inflows. “These new institutional investors are very slow and very sticky,
because the allocation, unlike to emerging equity or private equity, is coming
out of fixed income,” he noted. Booth asserted that new inflows “have nothing to
do with spreads, and nothing actually to do with fundamentals in Emerging
Markets—it’s got everything to do with a push factor, which is unfunded pension
liabilities.” Booth noted that most pension funds in the US must return 8% or 9%
to meet their liabilities. They are unlikely to get this from the US equity
market, he believes, nor from the US Treasury market. Peer group pressure has
also helped, according to Booth, as one pension fund manager tells his/her
colleagues about EM investments. Finally, consultants have to start learning
about the asset class; in the 1990’s it was considered esoteric, and demanded
lots of work—and thus was easy to reject. Unless conditions change dramatically
(e.g. unfunded liabilities go away, other major asset classes offer superior
performance, a prejudice against Emerging Markets returns, volatility in the
asset class increases, or global liquidity decreases) inflows are unlikely to
slow down.
Booth echoed the sell side panel that the more likely threats to the asset class
are factors such as protectionism or the rise of anti-globalization sentiment. Central Banks, Japanese pension funds and German insurance companies have just
“put their toe in the water; there’s a whole swathe of countries out there that
have also got unfunded liabilities, and they’ve only just started doing it,”
Booth concluded.
Five years ago, when one attempted to sell Emerging Markets in Japan, one would
have been met by a “polite bow and smile,” according to Anders Faergemann of AIG. “These same investors are now calling us, and they want to get invested not only
in external debt but in local currency debt,” he remarked.
External vs. Local Debt
diment
inquired how the panelists were structuring their risk. He also asked whether
the asset class would continue to exist in the next four years, or, for example,
would EM corporates just be added to the high-yield desks, and Brazil be
included on the FX desk.
Faergemann responded that the asset class is here to stay, but whether there
will be much external debt to be traded is a valid question. Investors in
external debt will hold on to any paper they have. On the other hand, Faergemann
pointed out that local markets might be more interesting as “there’ll still be
volatility there.” He referred to inexperienced players coming into the market
right now that will face a sell-off at some point; he will be watching to see
how they react. His portfolio is evenly divided between hard currency and local
currency debt, “but it’s only moving in one direction,” he stated.
Ashmore manages $12 billion in dollar debt, $4.5 billion in local currency debt,
and $4 billion in special situations, estimated Booth. He predicted that in five
years, his firm would mostly be doing local currency and private equity/special
situations. Booth also expects that in five years, investors will be putting
money into private equity, real estate, mortgage-backed securities, etc. While
some investors complain of a “lack of paper,” Booth highlighted the massive
potential of Chinese companies.
Treacher defended external debt, while conceding that he was a “dinosaur.” He
voiced some concern regarding volatility in local markets debt. Finally, Treacher noted that although he had spent his career by making money in external
debt, he now believes that “we may be at the start of a 20-year EM equity run.”
Carlson agreed with Treacher that the future might well belong to EM equity,
citing the credit improvement on the debt side. These credit improvements, in
terms of ratings upgrades—but more importantly corporate governance, FDI and the
institutionalization of the processes—makes a better equity market. Carlson also
concurred with Treacher that the external debt market is going to stay, and
echoed Booth’s comments that market participants would benefit from more fully
developed capital markets in developing economies. “There’s a future for all
sorts of investors, because the Emerging Markets are in a different part of the
macroeconomic cycle than the US and Western Europe; they’re on the upswing,” he
affirmed.
Panel Sanguine on Asset Class Outlook
diment
asked panelists what risks keep them up at night and what could derail recent
euphoria in the market. Treacher downplayed geopolitical risks (“the Philippines
proves whenever you get a military coup, buy it, it always works!”) but cited a
contraction of global liquidity as a greater risk to the market.
Carlson’s base case of a benign, low-inflation, growth environment supported
Emerging Markets bonds and equities. While acknowledging there are always risks
to the asset class, he viewed most of them as unlikely and difficult to hedge
against. Booth referred to his earlier comments on the “push” factor for new
money to enter the markets. He also stressed that for every potential risk,
there were opportunities for investors. Moderator Diment expressed his own
concern that a hard landing in China, which has been such a driver of many
emerging economies, could negatively affect the market.
The panel then turned to several region-specific discussions. First up was Latin
America. Booth spoke positively on Brazil while criticizing the Central Bank for
cutting interest rates too slowly. History prevents Ashmore from taking a
long-term view on Argentina, according to Booth, but he was comfortable with the
short-end of the curve and private equity. Faergemann alluded to the Argentine
market as being relatively illiquid in times of market moves, and added that its
neighbor Brazil “could hardly be in better economic shape.”
“Brazil is an investment-grade credit for all intents and purposes,” Treacher
asserted. He also repeated his previous EMTA forum criticism of hold outs of the
Argentine debt restructuring. “If you held out, you should not be in this asset
class,” he declared, calling the GDP warrants the “cheapest thing you have ever
been given free in Emerging Markets!” Diment preferred local-law Argentine bonds
in case of attachment issues from holdout creditors. He offered limited praise
for Argentine authorities for having “learned about fiscal policy” after the
country’s debt crisis.
African debt markets were next on the panel agenda. Treacher preferred private
equity situations in Africa to African local markets, while conceding that “I’m
sure someone will prove me wrong.” Carlson’s view on the ZAR was “constructive
from a range-trading standpoint.” He was a keen investor in Egyptian local
treasury bills last year, but has moved on to local corporates. Booth declined
to reveal his investments in Africa, stating “that’s the really interesting
stuff!”
In Asia, Treacher saw the Indonesian rupiah as “still offering value” and
admitted to being a trader of Philippines debt (“it really is the new Brazil ’40
– you basically just buy it when people are getting suicidal about things that
don’t matter too much.”) Carlson announced he was constructive on Philippine
debt both local and external, while differing from Treacher in that he saw
external debt as a long-term story rather than a trading opportunity.
Booth had positive comments on Indonesia and the Philippines, and was optimistic
on opportunities in India and China. Ashmore’s largest exposure in Asia is
concentrated in special situations, with FX a close second, he stated. Faergemann thought a gradual appreciation of the Chinese renminbi was possible,
“though whether that will matter to the market, I don’t know,” he admitted.
Liquidity Concerns Limit Exposure to EM
Corporates
"At
Ashmore, we do very little corporates,” Booth informed the audience explaining
that this was due to the firm’s focus on liquidity management. However, in the
future, Booth expected this would change. 5% of Carlson’s portfolio is in corporates, with small positions in any one issue because of his similar concern
for liquidity. Carlson expressed interest in wireless as well as steel company
issues.
Treacher took the opportunity to praise corporate bond analysts, who he declared
have a much harder job than sovereign bond analysts. “It’s a hard market, having
to look at 50 or 60 situations a week,” he observed.
Panelist Picks Vary Widely
Diment
concluded the panel with the traditional request for panelist picks. Carlson
reiterated many of his earlier comments, recommending Argentine GDP warrants,
Philippine external debt and Egyptian corporates. Treacher also returned to his
earlier theme of de-emphasizing political factors in selecting Ukraine
(asserting that the low debt/GDP ratio matters more than the elections). He
thought the Latin real estate market offered opportunities, and would be willing
to short Peru while cautioning that “every once in a while a short will kill
you.”
Booth declared that the BRL was an obvious choice and refused to short anything
in Emerging Markets. He thought that 2006 would offer more alpha
opportunities than 2005, based on his expectation of FX volatility resulting
from the end of the Fed fund tightening cycle, as well as election-related
market movements. Faergemann’s selection included the Brazilian, Turkish
and Indonesian currencies.