By Jonas Wäingelin, NordicInvestor
As financial markets are going through their most volatile period since the Global Financial Crisis of 2008, Nordic Investor interviewed Alejandro Arevalo, Fund Manager of Jupiter’s Global Emerging Markets Debt strategies, to find out how he has navigated the storm and repositioned his portfolios for the new environment.
NI: The world is in crisis mode and the market outlook is fraught with uncertainty. How has the corona meltdown hit you and how have you responded?
AA: We had already been positioning our portfolios more defensively in the months before the recent sell-off because we believed that some valuations were starting to look stretched and were no longer reflecting companies’ fundamentals. More recently, we also believed that the market was underestimating the likely impact of the coronavirus outbreak on global growth. As a result, we were already in a decent position at the start of February, before the sell-off started. We then implemented a series of overlay hedges to turn our portfolios even more defensive.
NI: How did you reduce risk as the crisis intensified?
AA: We reduced our high yield exposure and bought CDS protection through index and country-specific protection. We also shorted currencies that in our view are vulnerable to coronavirus, such as the Thai baht and the South African rand. We bought some exposure to US Treasuries, which helped as spreads rallied during the initial shock; however, we have trimmed this position as markets have turned more positive on the back of governments’ response to the virus. In addition, we have cut relatively illiquid names to avoid price volatility if there are forced sellers due to strong fund redemptions. We have also cut high beta names in Sub-Saharan Africa, some oil and gas names, Turkish exposure, our long local currency exposure in Nigeria and we have maintained 10%+ cash. So far, we have not seen significant outflows. However, we may raise our cash levels in the coming weeks as a precaution and to prevent us from potentially becoming forced sellers in these markets.
NI: How well positioned is emerging market debt to weather this crisis?
AA: Our market outlook remains cautious in the short term as spreads can still widen on the back of outflows. It’s important to remember EM was one of the main beneficiaries over the last year of negative or very low rates in developed markets. As investors pull their money out of funds and especially out of ETFs, bids get hit at almost any level, pushing spreads wider.
However, we believe that EMD continues to offer attractive opportunities and important diversifying features in good and bad times. In addition, EM corporates appeared to be in relatively good shape going into the coronavirus crisis: Since 2008, even though EM sovereign indebtedness has increased, EM corporate net leverage has remained virtually unchanged, moving from 1.1x in 2008 to 1.6x in Q3 2019.
NI: How can you avoid defaults and limit drawdowns?
AA: It is becoming increasingly important to conduct comprehensive fundamental research to identify the best quality credits. There are more than 800 issuers of EM bonds. With over 21 years of experience in credit research, our team has developed a strong investment process that we believe allows us to filter valuations effectively, helping us to narrow down the potential investable EMD universe.
However, due to the flurry of both positive and negative headlines, risk sentiment towards EM can swing dramatically from euphoria one minute, to panic the next. As EM is prone to these dramatic swings in sentiment, we believe it is prudent to hold an ‘all seasons’ portfolio rather than trying to make predictions about sentiment swings over the short term. In this way, we strive to benefit from some of the rallies when risk sentiment is high, while at the same time limiting drawdowns during periods of tougher market conditions. We view ‘knee-jerk’ reactions when sentiment turns as a positive, too, as they can provide some great buying opportunities in the EMD universe for active investors like us.
NI: Has the selloff now started to throw up more attractive valuations?
AA: Even though current market conditions are tough, panic creates indiscriminate selling, and indiscriminate sell-offs can present some exciting investment opportunities. As a result, we have started to selectively look for buying opportunities arising from irrational behaviour over the past few weeks, for example, by buying investment grade names trading well below levels seen at the end of February we are locking in very attractive yields. In the local currency market, we decided to start a long position in ruble denominated bonds in our view the Russian economy should be well equipped to handle lower oil levels after 2015.
Fortunately for our portfolios, the EM corporate bonds asset class is still almost 100% actively managed, unlike the sovereign and local bonds asset class, where there are large ETFs investing in the bonds, making them extremely volatile.
NI: How does this crisis compare with 2008?
AA: We currently expect the virus’s impact on the EM debt universe to be shallower but more prolonged than the effect of the global financial crisis in 2008, likely with a longer recovery time. We are looking out for various signs that could signal a sustained rebound. Potentially positive catalysts include stabilising outflows, convincing fiscal and monetary policy, and news of a vaccine. All of these factors could potentially turn the market around. Moreover, Asian economies, especially China, are likely to be the first ones to recover from the outbreak and could prove to be a leading indicator.
We will remain vigilant and discerning throughout this period, assessing the market environment in the different countries of the EM universe and filtering out EM corporates with the strongest fundamentals and attractive valuations. Similar to the 2008 crisis, in a couple of years’ time, we expect we will look back at this recent market sell-off as a good buying opportunity.