Emerging markets often represent great diversification elements for fund managers. Kirstie Spence, portfolio manager at Capital Group, explains in detail why it may be interesting to bet on debt in these countries at the current time, and what the best investment philosophy is in this field that is in the process of expanding.
Q: You started your career when emerging debt emerged as an asset class; How has it evolved over this time?
In the mid-1990s, emerging debt investing was a relatively small asset class, consisting of only 12-15 countries issuing in hard currencies. The broadcast was often carried out in response to crises in those countries. Until the 2000s, when local currency debt bonds and corporate bonds were introduced, changes were minimal. Since then, the asset class has gradually expanded to cover almost 70 countries, issuing a broader range of debt instruments. In addition, some countries have made good progress in establishing local yield curves.
Q: How does the rapid evolution of this asset class influence your investment approach?
This rapid evolution requires an investment approach that can adapt quickly. For us as investors, it is crucial to anticipate the next phase of development. To build and move forward effectively, we start with a stable foundation, leveraging the extensive experience of our emerging debt management team at Capital Group, whose average tenure is 30 years. This stability allows us to incorporate new capabilities and diverse points of view as markets evolve, which translates into a wealth of ideas essential for the success of a strategy. Additionally, we recognize the importance of analyzing people’s skills beyond their current roles.
For example, as demand for corporate bond experts increases, we will continue to evaluate whether our team has the necessary skills or whether we need to bring in external talent. This approach helps ensure that we can deploy our resources effectively based on our current needs. The abundance and improved quality of data in recent decades has been another significant development. This data allows for more effective analysis, but it is essential to keep our tools up to date to translate this information into informed investment decisions.
Q: You also mention the need to continue improving your investment approach; Do you think it will continue to evolve?
Risk management has always been a crucial part of our investment process, and its importance continues to grow. Our risk management capabilities have evolved significantly to be able to comprehensively assess our risk exposure and serve as an additional portfolio management tool. Our risk process is integrated across our systems, and is also independent, through our Quantitative and Risk Solutions team.
They partner with the investment team, allowing for a truly objective assessment of risk and how to manage it. The provision of analysts will also be a key aspect. Although our emerging markets corporate bond team has grown significantly in recent years, as the corporate bond market is poised for further growth in emerging markets, we anticipate the need for a larger team of analysts to cover these securities. over time.
To optimize the return on our investments, it will be essential to dynamically adapt our talent allocation to our evolving needs. We have deliberately created a “cross rate” feature for local markets to allow us to examine the asset class on a relative value basis across all regions, in addition to addressing it by region, which is the more traditional approach.
Another interesting aspect is the ongoing evolution of local yield curves and frontier markets, which may offer new emerging debt investment opportunities in the coming years. This requires a set of specific skills that allow you to find investment opportunities effectively. The study of these phenomena, together with the existing universe, highlights the importance of the resources necessary for the success of investments in this asset.
Q: Resource needs clearly require a strategic approach; How have you approached building the investment team?
Capital Group’s approach to investing in emerging debt emphasizes collaboration. We believe that everyone involved in managing client funds should be responsible for their decisions. Consequently, each analyst is responsible for managing the ideas that he has proposed, which are incorporated into the strategy. This not only provides analysts with portfolio management experience, but also improves the quality of analysis, as analysts are responsible for managing clients’ money and are compensated based on those measured results.
We also believe that smooth transitions are crucial to strategy success. We guarantee clear communication between the most senior members of the team, with long-term plans for events such as retirements. Additionally, we maintain coverage for each position on our team, along with a well-defined succession plan. Although not all outcomes can be predicted, our collaborative accountability and clear communication have helped us avoid major disruptions.
Q: It is clear that continuity is a way to minimize the volatility of results; How else do you approach risk management in relation to strategy?
Risk management is an essential part of the strategy and must be integrated into the investment process. An analysis-driven investment process plays a crucial role in effective risk management, as quality analysis requires a deep understanding of investment decisions, including both opportunities and risks. From a quantitative perspective, we complement on-the-ground research with our independent Risk and Quantitative team. Regular discussions with this team highlight areas that may require further study, providing valuable insights into risk characteristics that may not be apparent at first glance.
Q: What do you think of the current market and where it is going?
In recent months, the Federal Reserve’s interest rate decision has dominated markets, and the strength of the US dollar and rising interest rates have challenged emerging debt. China’s stimulus has not materialized as expected, which, given its position as the second largest economy in the world, has weighed on the evolution of this asset. Geopolitical concerns have also contributed to investor anxiety of late. Despite these challenges, the current emerging debt market shows promise.
Local currency yields have returned to post-taper levels, while spreads remain elevated compared to the last decade, making valuations look attractive. Furthermore, most emerging countries have effectively managed the recent inflationary cycle and, broadly speaking, domestic fundamentals are in good shape, with manageable external balances and a credible fiscal policy.
This favorable macroeconomic context in emerging countries reinforces the positive outlook. Similarly, although local currencies face headwinds from the strength of the US dollar and short-term interest rates, valuations are attractive as emerging market exchange rates weakened in response. to the challenges of growth in recent years and, from these levels, has the potential to improve investment profitability opportunities.
Q: Given that you have been analyzing and investing in emerging debt for almost 30 years, to what extent do you think experience contributes to the success of an approach?
Experience is very important in investing in emerging debt. Despite the changing nature of this asset class, there is a recognizable pattern to its movements over the past three decades, so having a core team with experience in these periods is invaluable. However, experience alone is not enough; It is essential to supplement this core team with new ideas and skill sets. In terms of asset allocation, EM debt is a tactical asset class, and trying to time the market has historically been a challenge. A long-term commitment, both on the part of the investment team and clients, can offer the best results.