For more than a decade, emerging markets (EM) debt has, in aggregate, lagged its developed market counterpart. But a constructive macro backdrop echoing the commodities super-cycle that began in the 2000s means that could be about to change, according to Patrick Zweifel, chief economist at Pictet Asset Management.
“Since the peak in April 2011, there’s been a slight underperformance, a slight loss of 0.1 per cent annualised,” Zweifel told the Top1000Funds Fiduciary Investors Symposium in Singapore. “And this is when emerging market local debt started to clearly underperform developed market [debt] as well as US Treasuries, and that has lasted for more than 10 years.”
“So the question that is often raised from investors is, is it still an asset class worth investing in?”
Zweifel thinks the answer is “yes”. But to understand why, it first makes sense to group different EM countries by the macroeconomic factors they’re exposed to: commodity exporting countries versus manufacturers; creditors versus debtors; open economies versus traders; and China, which sits alone.
“The main important distinction when we talk about emerging market debt is the distinction that we make between creditors and debtors,” Zweifel said.
“The reason why they’re very different is because the debtors economies would be much more sensitive to higher global rates and much more sensitive to the dollar, because part of their debts are actually issued in dollar terms.”
During the commodity boom, Zweifel said, commodity-exporting countries returned an annualised 18 per cent while debtor countries returned an annualised 15 per cent as the dollar declined and the US 10-year bond yield declined by more than seven basis points. During the lost decade that followed – when the dollar and 10-year bond yield both rose – the growth of both debtors and commodity exporters declined sharply.
Pictet looks at five macro factors to figure out what will drive the performance of the EM set. Local policy rates are at levels not seen since the commodity boom and are now declining towards neutral levels; global trade is rising, driven largely by EM countries (and Zweifel thinks that, as was the case with Trump 1.0, tariffs won’t curtail global trade but “redistribute” it, because EM markets now trade more and more with each other); and the relative strength of China’s exports.
The US dollar also looks overvalued, Zweifel said, with a possible trigger for reversion coming in the form of policy and growth divergence between the EM and DM countries, while a rebound in local manufacturing supported by rate cuts would be supportive of commodity prices.
“[In the super commodity cycle] all those five factors were positive,” he said.
“When all those factors are positive, it’s a super boom. We now have three out of two – which is not too bad – and two are neutral.”
Zweifel also discussed the outlook for India, the markets of which have become an increasingly popular destination for global capital as investors are drawn to its growth story. Zweifel pointed out that India is a closed economy, highly indebted and heavily indexed to manufacturing, and that, in terms of its debt, it “wouldn’t be the ideal country in which we would be right now”.
“But in terms of its evolution – the reason why you invest in emerging markets is to capture the gross dividend and because of the idea that a poor country will converge towards a richer one,” he said.
“India starts from a very, very, very low level. So despite the fact that it’s, again, a big economy and growing fast, it has a lot of catching up to do. I think there’s this long-term story regarding India that has made it very attractive, because they’re far from being even where China was in the early 2000s. It’s a very long-term story.”
