Matt Ritchie asks Thomas Delabre, emerging market portfolio manager at Amundi, how pension funds should make best use of emerging market debt given the uncertainty surrounding the asset class

How has emerging market (EM) debt performed over the first quarter?
EM assets performed fairly well, and there are two main reasons for this: first, hard currency debt performed very well because of new flows coming into the market and very attractive valuations; and second, the global backdrop was supportive for riskier assets.

This was a continuation of a trend that we observed last year when money flowed into the asset class as new investors were attracted to it, despite risks such as the unrest in the Middle East and concerns on inflation. Performance in the EM fixed income universe in general was fairly good. I think this surprised quite a lot of investors.

How do you view the short-term outlook?
In the very short-term we have become more cautious on EM FX and EM assets, not because we think the fundamentals have changed greatly, but because we have had a good run since the beginning of the year and valuations, on a cyclical basis, are no longer as compelling as they were. The global backdrop remains supportive, but we think the market has now factored this in.

We also have some headwinds coming from European restructuring and higher oil prices. There are always cyclical ups and downs and we might be heading to some downs in the near future, potentially over the next couple of months.

What does that mean for Amundi's portfolio?
We have become more neutral, less aggressive in positioning our portfolio. We have decided to take some profits; not only because we have seen good performance since the beginning of the year but also because of current valuations.

How is the picture further ahead?
My view is that over the medium-term the EM income story remains very strong. Although some investors are questioning whether inflows into EM fixed income will dry up after two very strong years, we have always argued that there is an ongoing structural shift in allocations from the developed world into EM asset classes by big institutional investors. This includes significant EM institutional investors, such as Asian central banks, moving into emerging markets.

How does the less attractive short-term outlook affect pension funds?
The key story about big pension funds allocating more of their global fixed income exposure into EM fixed income is still very much there. When investors look at the fixed income universe, they say 'well, what's my market? – US treasuries, European bonds'. But German and French yields are very low and higher yields can only be found on the European periphery, which is not very attractive. The story is not as compelling as that of EM hard currency, corporate debt, corporate debt for credit, or the local debt market or sovereign market.

Some view EMD as a scarce asset class. Is there a risk that people going to market to access EMD may not be able to?
There is a sense among some investors that, while there is a scarcity of assets, this asset class is developing faster than EM equities which represent a much more mature market. Right now, the investment universe for the GBI local debt
bond index for EMs has a market cap of around USD $800bn. If you include countries such as China and India, this total can easily increase to USD $1,500bn. As you add more countries, this figure will grow further, so the market capitalisation will grow in line with the investable universe.

In addition, most countries have debt, while some countries have neither a developed equity market nor companies which are suitable candidates for IPO. Sovereign debt is spread broadly – across Africa, Latin America, Eastern Europe, Asia – so debt is not a scarce asset in general.

Written by Matt Ritchie

Nothing in this article is intended to be investment advice to any person, and no reader should rely on anything in this article when making any investment decision. This is not an offer to invest in any Amundi Fund

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