Why the GCC remains in favour with emerging market debt investors
In a tough year, the region has emerged as something of a port in the storm
by Meno Stroemer, Head of Corporate Bonds and Theo Holland, Senior Portfolio Manager,
Fisch Asset Management
6 December 2018
It has been a challenging year for investors in emerging market (EM) debt.
Hard currency corporate debt has returned minus 2.0 per cent, and hard currency sovereigns minus 4.8 per cent. Local markets have been still harder hit, with sovereigns in domestic currencies suffering losses of minus 5.5 per cent.
These negative numbers are not unique to EM, however. According to Deutsche Bank, whose data covers a wide range of asset classes, 2018 is shaping up to be the worst year on record for wider market performance in dollar terms.
That said, in Fisch Asset Management’s area of focus – corporate debt – the Middle East has offered a port in the storm, with the region’s companies delivering the only positive returns among EM corporate regions year-to-date (YTD).
What made 2018 such a challenging year and why do we expect Middle East corporates to continue to excel in these volatile times?
A volatile backdrop
If, in 2017, markets were pleasantly surprised by how little the policies of US President Donald Trump impacted returns, in 2018 his “trade wars” became front of mind. And although the recent G20 in Argentina has once again becalmed US-China relations, few investors expect the issue to have gone away completely.
The second challenge for markets in 2018 was a US Federal Reserve in full-on hiking mode, making for a rise in the US government bond yields which underpin valuations across all asset classes. While Fed president Jerome Powell seems to have moderated his tone recently, we expect this could change once more.
Finally, 2018 saw a spate of idiosyncratic challenges across emerging markets. Chiefly, Argentina’s having to go the International Monetary Fund; Turkey’s currency coming under enormous pressure; and national elections in major markets such as Brazil and Mexico. In our markets, such challenges and changes are a constant.
GCC: safe-haven and opportunity
A recent visit to the GCC, which provided the opportunity to exchange views with both investors and issuers, served to remind us why, when set against this backdrop, the region remains among our favoured geographies. Looking ahead to 2019, we expect the following factors to drive returns:
Firstly, we anticipate an improved political backdrop in the region in 2019, with frayed relations among certain countries likely to improve. With continued pressure from international allies coupled with the growing complexity of Middle East politics, an improvement would be most welcome for international investors.
Additionally, an important degree of technical support in 2019 will come from the inclusion of more GCC countries’ dollar bonds in JP Morgan’s flagship EMBI indices. Currently, of the regional names, only Oman is included in these benchmarks and while this has not put off seasoned EM debt players, index inclusion will undoubtedly bring further buyers to, and greater depth in, the region. This will benefit both sovereign and corporate issuers – unsurprisingly, given the close links between the two.
Of course, the GCC continues to offer an active and supportive local investor base. We continue to see significant local participation in new issues from the region, providing confidence and understanding in the paper. We don’t expect this to change, although we also believe that there are opportunities for investors in the region to increase their exposure to other emerging economies, such as Latin America and Emerging Europe.
Fourthly, at a time of renewed volatility in energy prices, it is important to remember that the GCC is not simply an oil story. Excellent companies exist in sectors as diverse as retail, infrastructure, health care and financial services. While real estate faces well-flagged challenges, we believe the sector is now mature enough to manage these. In sum, investors forget at their peril that the region has taken great steps to diversify away from its traditional reliance on hydrocarbons.
Finally, we have an overall positive view of the emerging market debt asset class in 2019. Chiefly, we believe that the headwinds posed by rising US interest rates will lessen; we find the election schedule in emerging markets to be less meaningful and, hence, less disruptive; we forecast that supply technicals will be more in our favour; and, importantly, we see that valuations have improved.
GCC markets will benefit from these trends along with other regions and, together with the factors detailed above, this points to an encouraging outlook for the region’s debt market in 2019.
Meno Stroemer is Head of Corporate Bonds and Theo Holland is Senior Portfolio Manager at Fisch Asset Management, which is a member of The Gulf Capital Market Association.