Emerging Market Debt Warning

30 Jul

Mike Riddell, fixed interest fund manager and heads up the Emerging Market (EM) Debt Fund had to say – he thinks emerging market debt may once again provide a good buying opportunity; however, at current levels, he thinks investors would be wise to look elsewhere. 

Investors will be well aware of the Emerging Market narrative – the asset class will surely outperform because of low debt levels, high growth and strong demographics.

The flaw in this argument in relation to EM debt:-

  • the performance of EM Debt has very little to do with GDP growth rates or demographics
  • it has been driven more by global risk appetite, US Treasury yields and the US dollar
  • instability of the Eurozone

Mike Riddel has highlighted concerns that emerging markets will face further country – and region-specific risks. 

He has sited the potential of an economic rebalancing in China could pose a particularly big risk to the asset class. China has had the biggest credit bubble in the world in the last three years, and rebalancing may result in GDP growth falling to as little as 5 to 6% per annum.

His opinion is, the risks facing EM debt appear to be rising, and while some exchange rates have begun to move, the asset class does not appear to be pricing in these risks.

My Conclusion

I believe that the risk reward ratio does not support holding this asset class and the downside risk dramatically out-weighs the upside potential.

This is not an asset class I currently hold in client’s portfolios, so personally I agree with Mike Riddell’s opinion.

There is no such thing as a bad asset class rather bad valuations – I do not expect this asset class to provide good valuations in the near future. (A price correction could easily reverse my opinion as the valuation and potential of positive returns change an asset class from being out of favour into an asset class which is in favour.)

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