Finding the Right Emerging Markets Debt Position in 2018
GILLIAN KEMMERER: Welcome. I’m Gillian Kemmerer. Emerging markets debt saw a phenomenal start to the year with pockets of opportunity ranging from Latin America to Eastern Europe. Today, VanEck Portfolio Manager Eric Fine is here to tell us more about the markets to keep an eye on and the hotspots he’s avoiding. Eric, thanks for joining us.
ERIC FINE: Good to be here, Gillian.
KEMMERER: Let’s start with a big picture view of this market that has really been an investor darling this year. What are some of the key things you’re keeping an eye on, both on the positive and negative sides?
FINE: Sure. Well, there are some big imbalances. One of the most basic ones is the world levered up. The other one is interest rates may be rising. So that, we think, is the key tension. I’ll put it a different way. Let’s say things are bad, meaning the economy declines. That’s more clearly negative for credit spreads, they should widen for currencies. Let’s imagine things are good. Let’s say a reflation trade happens and interest rates rise. Well, interest rates rising with a levered economy is also risky. So we see two basic scenarios, bullish or bearish, that could generate big challenges and headwinds for the emerging markets.
KEMMERER: So whether it’s good or it’s bad, emerging markets debt could see a negative impact?
FINE: Whether the global economy is good or bad, you need to find the right place to be in emerging markets. One of the themes is: It might be getting dark, but you can only see the stars when it gets dark. And we think there are plenty of things to do in emerging markets. But we don’t want to wake up in the morning and think about Janet Yellen or Kim Jong Un – some of these big global drivers. Or if we can, the turn in the global economy. We want things that make sense, period, in both of those scenarios. Not necessarily that either one is a central case, but we want to make sure that the portfolio does well in all of those scenarios.
KEMMERER: So, in light of this global view, how has VanEck changed up its positioning?
FINE: So as you said at the beginning, Gillian, it’s been a good year for emerging markets. It’s extremely popular – record inflows basically to the asset class. On the margin that’s a bad thing. Obviously when something’s popular you want to be on the other side of it. But we participated. We outperformed up until the third quarter. And so we were long and we had local currency. We had some duration. But the big changes we’re making in anticipation of this trickier global scenario is: number one, we reduced local currency. It’s high beta. It’s also extremely popular, all of the surveys were showing it’s a big overweight. And it is ultimately the shock absorber that emerging markets have in a downturn. So, number one, we reduced local currency exposure. We also reduced duration. Spread curves are very flat and let’s say the Treasury Bonds sell off 100 basis points, you’re going to be down 8%. So two things come from that, one, don’t be down 8%, so have the short duration. The other is, if your spread is 80 basis points, you know what, it’s going to take years of that spread over Treasuries to be paying you to make back that loss. Whereas if you have high spread and short duration, you probably won’t take the loss from the hit to duration, and the spread, if you do, the spread will pay you back pretty quickly. So that’s the second thing we’ve done.
The third is we’re looking for idiosyncrasy. Like I said earlier, I want to wake-up in the morning and not think about Kim Jong Un. And not think about Janet Yellen or the U.S. Fed. And I’ll throw some names that I think should be self-evidently uncorrelated or idiosyncratic. Ecuador: nothing to do with anything, right. We think they’re going to make progress and have some sort of rapprochement with the IMF, for example. Or Mongolia: clearly, probably even superficially, you don’t need to know much about it to think, well, it probably has little to do with anything under an IMF program. Ukraine, right, also idiosyncratic. But those are the types of things we’re doing, reduce local [currency], reduce duration, and we’re looking for idiosyncrasy. Really if we can find something that doesn’t seem to have anything to do with anything else, we’ll like it more.