With the Bank of Canada deciding, unsurprisingly, to leave interest rates unchanged this week, the conversation of where investors can find meaningful returns once again comes to the fore. The consensus is that if Canadian rates are going to be moved in any direction it will be lower, and although the Federal Reserve is expected to hike rates south of the border three times this year, globally, rates remain low. So, in the current environment, where can Canadian investors find decent returns in 2017? According to Amundi Asset Management’s, Sergei Strigo, emerging market debt is an attractive solution.
“It was a very profitable investment last year and in my view it remains so this year even following the outcome of the U.S. presidential election and rising interest rates in the U.S.,” says Strigo, who is Head of Emerging Market Debt & Currency at Amundi. “Within fixed income there are very few opportunities for investors to find meaningful returns. Emerging market debt remains one of those areas where the yields and returns are going to be higher than traditional asset classes.”
Strigo sees small improvements in the macroeconomic state of the vast majority of emerging market countries, which further solidifies his belief in the space. GDP growth rates, current account balances, and fiscal balances are all improving. The level of currency flexibility is another key reason why Strigo believes emerging market countries are going to be more resilient going forward.
“The market is focusing on potential fiscal stimulus in the U.S. which will be beneficial for some commodities markets, which emerging markets have significant exposure to,” Strigo says. “Investors are seeing fiscal stimulus as being beneficial for some emerging markets countries, but not all. However, increased noise around protectionism from the U.S. may have negative impacts for some emerging markets, but again, not all.”
Strigo differentiates between three distinct asset classes within the emerging market debt space: U.S. dollar denominated bonds (also known as hard currency bonds), local currency bonds, and foreign exchange itself. He currently sees particular opportunities in hard currency bonds, even though current valuations mean they’re not cheap. “They performed very well in 2016 and well again so far in 2017,” Strigo say. “Hard currency bonds offer investors relative safety because they’re less volatile and have no currency risk because they’re U.S. denominated. There is just the credit risk and we believe that has actually lessened, partly due to currency flexibility, which mitigates default risk in a lot of emerging markets.”
On the local currency side, Strigo sees opportunities in countries where inflation is being reduced and central banks are cutting interest rates. The three main countries he likes in that space are Brazil, Russia and Indonesia. They have all started to cut interest rates, although the nominal rate in Brazil remains in the double digits.
“The currency side is the asset class where we’re much more cautious,” Strigo says. “In an environment of interest rate hikes in the U.S., the U.S. dollar is expected to be strong against everything else this year including emerging market currencies. So, we’re cautious in the emerging market currency space in 2017.”