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Summer Forum - June 26, 2012

Commodities, EM Returns Discussed at 15th Annual London Summer Forum

EMTA’s 15th Annual Summer Forum was held at the Bank of America Merrill Lynch office in London on Tuesday, June 26, 2012.  125 EMTA Members attended the event, which included two panel sessions on the EM outlook and covered potential returns, commodities and specific EM countries.

Alberto Ades (Bank of America Merrill Lynch) began the session by reviewing comments made at the 2011 Summer Forum when panelists had encouraged investors to take advantage of G-10 economic woes to buy EM debt.  Ashmore Investment Management’s Jerome Booth affirmed that this remained the case.  “Not only can EM assets be used to boost portfolio returns, but they can also be used to reduce risk; and there remain powerful arguments for asset allocators with a long-term perspective to buy EM,” he argued.  With an increasing number of local buyers invested in EM issues, the investor base has diversified, and, unlike G-10 investors’ belief in a “risk-free” investment, EM creditors have a clearer perception of risk.

On the outlook for commodities, Graham Stock (Insparo Asset Management) noted his generally optimistic views, while stressing that each commodity must be considered separately.  He acknowledged that there was “undoubtedly some speculation in prices in Q1 that was washed out in Q2.”  Oil in the $90 - $100 range was a “reasonable assumption,” with growing demand in India and China balanced by new discoveries in a range of jurisdictions, including East Africa.  Stock believed that the long-term pricing trends of metals provided greater cause for optimism than those for oil because of less innovation in the metals industry and weak investment.

Pioneer Investment Management’s Greg Saichin discussed the short-term risks of a Chinese economic slowdown, which he reasoned had become a consensus view.  He also noted the upcoming political transition in the People’s Republic could pose a danger.  Brazil was the most exposed EM country to a Chinese slowdown, Saichin believed, and EM countries generally face a challenge of reducing their dependence on one main commodity.

The outlook for the dollar vis-a-vis EM currencies was debated.  Booth viewed market focus on dollar-euro rates as being misplaced.  “That is the side show; they are both going down,” he declared.  When Central Banks felt less concerned by European developments, “watch out, they will start selling dollars,” he warned.  ING Investment Management’s Rob Drijkoningen noted that, as a group, portfolio managers all tend to “fight the last war” and need to adjust to new realities in the marketplace.  As for him, the best long-term opportunities in EM FX were the South African, Israeli, Malaysia and Brazilian currencies.

Panelists concurred that asset class inflows remained strong.  Risk appetite was a “4” on a scale of 1 to 10, in Stock’s opinion, compared to “2” last year.  Saichin observed that clients wanted to invest in countries with strong Central Bank reserves and low debt/GDP ratios, “...that is, countries with little risk of defaulting,” he stated.  Booth voiced confidence that investor allocations to EM would grow over time, but conceded that even those who wished to be more aggressive felt compelled to avoid breaking too far ahead of “the herd.”

On the frontier markets, Stock preferred Qatar external debt, while viewing local markets as opportunistic investments (Stock spoke most positively on Nigeria, while stating that Egypt was likely to “stay interesting”).  Booth noted that many African countries were well-positioned for future growth, and predicted many sovereign issuances in the future.  “This is not the same market when Liberia traded at 5/8 in the mid 1990s,” he observed.

The outlook for corporates was also a focus of discussion.  Drijkoningen believed that yields in EM corporates fairly compensated investors for their default risk.  Saichin discussed increasing corporate liquidity risk, adding that portfolio managers must try to mitigate such concerns.  Booth saw “huge” upside in the corporate market and believed that investors can “do much better than the index.”

Following the investor panel, Brett Diment (Aberdeen Asset Management) moderated a discussion featuring sell-side experts, with speaker views on potential 2H returns varying.  Christian Keller (Barclays) believed hard-currency EM debt could return as much as 7% by year-end, while Pablo Goldberg (HSBC Securities USA, Inc.) conceded that he was less bullish, with 1-3% returns possible, depending on US Treasury performance.  Richard Segal (Jefferies) was most enthusiastic on the potential returns on local market debt.  Royal Bank of Scotland’s Demetrios Efstathiou predicted a modest 2% return overall, while commenting that inflows into both hard currency and local debt remained strong.

Diment also polled speakers on the outlook for commodity pricing following the earlier buy-side discussion.  Panelists highlighted the difficulty of predicting commodity pricing, although Efstathiou suggested that Chinese demand for metals provided good support.  Keller opined that Chinese demand for commodities generally had bottomed, and “there might be some surprises on the upside in Q3.”  Oil would rebound over the next two or three years, he predicted, with a $100 per barrel price likely.  Keller concluded that this would help countries such as Russia, without triggering inflationary pressures.

Turning to individual markets, Goldberg expected a continuation of “bad policy choices” in Buenos Aires, although resilient soy pricing would continue to be supportive of Argentine debt.  He expressed concern about “Venezuela’s massive fiscal stimulus, and how they will mop it up,” as well as current oil prices, while still favoring the country’s debt.  Segal believed that President Chavez will be re-elected, but warned that there could be “real chaos” in coming years. 

Segal recommended Ukraine as a hard currency play, while Efstathiou adopted a bearish tone (“I thought I understood that country, but now I realize I don’t understand it at all”).  Keller “would avoid an overweight” on Ukrainian debt. 

As for Hungary, Segal raised concerns over medium-term foreign debt, “which makes me nervous,” but spoke positively on the near-term outlook.  Keller concurred, “I’d play it from the technical side; it’s not my top pick, but someone will be happy that they bought the debt on the right day.”

Changes in the buy-side were also a topic of panel discussion.  Several speakers highlighted the increased participation by Asian investors, whom they noted were reaching in to a variety of EM assets, instead of a previously almost-singular focus on the BRL.  (“We have a trip planned for Lithuania, Romania, Hungary and Poland for Asian investors...who would have thought that a year ago?” observed Efstathiou.)  Goldberg added that increased inflows from European managers had resulted as investment-grade only accounts were forced out of downgraded EU sovereigns.  Keller observed that EM investors are increasingly dipping into EM corporates.