TCW – an update on Emerging Market Debt

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  • 09 mins 18 secs
David Robbins, Group Managing Director, Emerging Markets, TCW, discusses the company's approach to emerging market debt, navigating market risk, the opportunities in EMD compared to other asset classes and where he currently sees opportunities in hard & local currency debt.

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TCW

PRESENTER: Well joining me now is David Robbins, Group Managing Director, Emerging Markets TCW. So David, it’s good to have you with us today.

DAVID ROBBINS: Thanks for having me.

PRESENTER: So let’s start with TCW’s approach to emerging market debt, talk me through it.

DAVID ROBBINS: Well, you know, we’ve been looking at emerging markets for a long time at TCW. I’ve been in the market 35 years, my colleague has been in almost 45 years, so we started when it was called the LDC market, the less developed countries, and really seen its expansion and evolution over many years. We think the best way to approach the market is to take a total return approach. To look at every single asset class in the market - dollar sovereigns, dollar corporates and local currency - and really cherry pick what the best risk-reward opportunities are across the entire asset class.

We do that with a very experienced research team that really takes a look at the country first. We believe it’s most important to understand what’s going on with the sovereign. Where it is in the cycle, you know, from an economic perspective, from a political perspective, what are the strengths of institutions, what is the quality of corporate governance, all of these things are extremely important in evaluating where a country is, and what potentially is the best risk-reward investment that you can take advantage of where that country is in this particular point in the cycle.

PRESENTER: And how are you navigating some of the market risks, for instance the US China trade war, inflation?

DAVID ROBBINS: Well clearly there’s a lot that impacts emerging markets, both from a global perspective and internally domestically as things change in individual economies. The things that have buffeted emerging markets this year are really three things. The first is the differentiated growth. We’ve seen stronger growth in the US, weaker growth in Europe, and obviously that’s had an impact on trade. The second are trade concerns, what’s happening with China. Clearly the trade war has had an impact on people’s perceptions. It’s less of a large economic impact, but more of a psychological impact, and that’s certainly affected emerging markets. And I’d say the third thing is idiosyncratic stories within emerging markets, the Argentinas, the Turkeys of the world, which have to some extent self-inflicted problems that they’ve had to deal with, and they are starting to deal with them and turning the corner.

So when we look at these situations, a lot of the research that we do is really focused on finding turning points. We want to really find a credit that either has been a bad actor and all of a sudden is really forced to do the right thing, maybe go to the IMF or reform policy, or there’s political change that creates a new administration and better policy. And certainly we want to avoid those countries that have already been rewarded for good policy and all of a sudden get complacent, and then get more lax.

So understanding those turning points is a very important part of the strategy. And interestingly enough in emerging markets right now we may be hitting one of those turning points, because simply in the early part of the year as you were getting hit by the differentiated growth in the US, the stronger dollar, the China trade wars, the weakness in Argentina and other countries, a lot of those issues look to be in a position where they’re starting to be resolved. So when we look past the mid-term elections that we just had yesterday, we’re going to have divided government in the US. But I think the weaker performance of the stock market in the US really led the US administration to a little softer tone on the trade talk with China. And perhaps while there are longer-term issues within that debate, perhaps we’re moving to a scenario where things are going to be a little bit softer in terms of their tone.

So that’s improving slightly. I think growth in the US really is in the process of peaking. I mean clearly we’ve had significant fiscal stimulus and tax cuts, and that’s really enabled the US to grow substantially higher. But we are getting the sense that growth is starting to weaken here in the US and hopefully starting to turn around elsewhere. And one of the things we are going to watch closely is how the fiscal stimulus that China is really working on, whether it’s tax cuts, visa requirements cuts, increases in lending, are going to help growth there over the next three to six months.

So as that differential narrows again, the US slows down, emerging markets and China and Europe pick up, again we think that’s a turning point and is going to really help benefit emerging markets. And then I think the last thing that’s hurt emerging markets has been really idiosyncratic issues within emerging markets itself. How individual countries have reacted to the tightening financial conditions in countries like Argentina and Turkey, which were most vulnerable, have really gone through some pretty difficult time periods. But at the same time I think we’ve reached the bottom in many of those issues and we’re starting to see recovery.

So much of what we do on the research perspective is looking for turning points, both at the sovereign level and in terms of the geopolitical level and the policy level. And we’re starting to be a little bit more encouraged that things are looking a little bit better.

PRESENTER: But emerging market debt has been under a lot of pressure this year, so how would you say EMD compares to other fixed income asset classes in terms of opportunity?

DAVID ROBBINS: Well we look at it two ways. When I look at the dollar sovereign debt, we think it’s trading at, or the index is trading at roughly 355 to 360 basis points over; that’s right on their long-term averages. So, on a historical basis I would say it’s fairly priced. When we look at it relative to other asset classes, it looks cheap because EM is one of the only asset classes that is trading at its historical averages; most fixed income asset classes are trading at the very tight end of the range. So the spread of EM relative to other fixed income asset classes has widened. And that’s one of the interesting things we’ve seen, is as spreads have widened out almost 100 basis points from the tights earlier this year, we’re starting to see flows into the asset class as investors sell more expensive classes and add to EM.

On the local currency side, we’ve had a significant repricing on local currency, and a good portion of that is related to the strength of the US dollar. And as the strength of the US dollar subsides, we think that’s going to be a very unique longer-term opportunity in EM local currency.

PRESENTER: So where then are you seeing the current opportunities in hard and local currency debt, and what do you think will be the characteristics through the dollar turn?

DAVID ROBBINS: Well I think in short term we like local currency, because we still see a little bit of volatility in the local currency space, so we’re more comfortable being in the hard currency debt. But I think longer term the more interesting and compelling trade is really local currency. Because right now people are focused on the cyclical differences: stronger US growth versus weaker US growth elsewhere. Soon investors will start to focus on the structural differences. The fact that we have a high current account deficit, that we’re going into a potential period of recession several years from now, with the highest fiscal deficit we’ve had in the US during peacetime, a 5% fiscal deficit.

So debt to GDP in the US is moving towards 100% over the next several years. Debt to GDP in emerging markets is only at 50%. So we think as people focus on the structural issues and as you start to see growth slow down in the US and pick up elsewhere, you know, that’s really going to be an indication that the dollar has peaked, and I think you’ll see a longer-term upturn in emerging market local currency.

PRESENTER: Well, finally, what have investor flows been, and is it time to add?

DAVID ROBBINS: Interestingly enough even with the negative performance in the asset class this year we’ve seen significant inflows into our products. We’ve seen about $2 billion to $3 billion of inflows into both a combination of hard currency and local currency products in emerging markets. And I think what we’re seeing is investors are taking profits or selling asset classes that are at the very tight end of their ranges, and adding emerging market debt, which is trading at, it’s significantly cheaper from a historical basis.

So when we look at the market, we think it is time to slowly scale in to the asset class. Hard currency debt is fairly priced, again as I said before there are very few asset classes in fixed income in the US that are fairly priced, and so as a result we think creating portfolios with 7% yields and double-D credit quality provides a nice cushion in an environment where you may see rates rise marginally over the next several months. One the other hand local currency presents the more interesting longer-term opportunity. As I said before when we focus less on the cyclical issues and more on the structural issues, we think some time in 2019 you are going to see the dollar peak. And as a result you’re going to see a longer-term up-trade in emerging markets local currency paper.

PRESENTER: David, thank you.

DAVID ROBBINS: Thank you very much.