Polina Kurdyavko and Anthony Kettle’s views on an unconstrained approach to emerging market debt
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Efforts to mitigate the economic fallout from the Covid-19 pandemic are reducing returns from developed world ‘safe’ assets and throwing a spotlight on riskier but potentially higher yielding strategies including emerging market debt.
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In this Focus, Polina Kurdyavko and Anthony Kettle, who manage BlueBay’s Emerging Market Unconstrained (EMU) Bond Strategy, offer their thoughts on the outlook for emerging markets. They also explain how their team integrates views across the interest rate, currency and credit markets and takes account of Environmental, Social and Governance factors.
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This document may be produced and issued by the following entities: in the European Economic Area (EEA), by BlueBay Funds Management Company S.A. (the ManCo), which is regulated by the Commission de Surveillance du Secteur Financier (CSSF). In Germany and Italy, the ManCo is operating under a branch passport pursuant to the Undertakings for Collective Investment in Transferable Securities Directive (2009/65/EC) and the Alternative Investment Fund Managers Directive (2011/61/EU). In the United Kingdom (UK) by BlueBay Asset Management LLP (BBAM LLP), which is authorised and regulated by the UK Financial Conduct Authority (FCA), registered with the US Securities and Exchange Commission (SEC) and is a member of the National Futures Association (NFA) as authorised by the US Commodity Futures Trading Commission (CFTC). In United States, by BlueBay Asset Management USA LLC which is registered with the SEC and the NFA. 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THE INTERVIEW
Do emerging markets demand a more
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Emerging markets were still able to cut rates and stimulate that way
She thinks it is easy to overlook the impact of long-term structural changes. “For me, the biggest shift, particularly over the last 10 years, is the majority of emerging market countries moving towards a flexible exchange policy,” she says, “which means currencies can take the brunt of adjustments – helping to avoid boom/bust scenarios.”
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Polina Kurdyavko and Anthony Kettle are tasked with building a view of emerging markets that is wide and deep. They use BlueBay’s extensive team of sovereign, corporate, and local currency specialists to bring together a mosaic of insights across the key sub-assets and issuers, so they can manage their emerging market unconstrained bond strategy dynamically through the emerging market cycle.
Wider world
he roll-out of vaccines for Covid-19 through 2021 may prove uneven, but it has helped fuel a degree of optimism in global investment markets. Many investors are hoping that higher yielding – and relatively risky – assets such as emerging
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There remains a chance that over-enthusiastic QE might fuel inflation or erode debt sustainability. But Kurdyavko, who started covering emerging markets in 1998, is hopeful that 2020’s response indicates “emerging markets have come a long way in terms of the maturity of the policy framework and their ability to use key levers to cope with a crisis.”
dynamic approach?
But periodic crises over the last decades have given emerging markets a mixed record – with returns often driven by the precise timing of the investment across the market cycle, or by orientations towards a benchmark or a specific sub-asset such as foreign currency, sovereign debt, or corporate credit.
But she’s most encouraged by the relatively robust performance of corporate issuers. Paradoxically, it may have helped that, “emerging markets have been in a sluggish growth environment for the last 10 years, with corporate issuers delevering since the 2015 oil price crisis,” she says. “On top of that, the policy mix has not derailed those balance sheets so far.”
The biggest shift, particularly over the last ten years, is the majority of emerging market countries moving towards a flexible exchange policy
The team say the initial shock of Covid-19 – emerging markets suffered unprecedented capital outflows in March 2020 – gave way to positive surprises. “The first surprise was the ability of many emerging market authorities to conduct a degree of quantitative easing (QE) and, more broadly, to otherwise conduct quite an orthodox policy mix in an environment of great uncertainty,” says Kurdyavko.
Jewell says that BlueBay takes ESG risks into consideration across all its investing, including conventional strategies, but that “our global high yield ESG strategy sets a much higher bar, beyond investment materiality, on how we integrate ESG into the decision making.”
The lack of inflationary fears going into the crisis meant that, “when you saw the Covid pandemic at its worst, with a lot of FX weakness coming through, central banks in emerging markets were still able to cut rates and stimulate that way,” says Kettle. With luck, emerging markets will retain that new flexibility.
Inflation implications
CoCo triggers are normally set well below where we would expect to see the point of non-viability for a banking institution today
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There was a significant number of sovereign defaults and debt reprofilings in 2020, including Argentina and Ecuador. However, Kurdyavko says Covid-19 was not the key factor, at least in Argentina’s case, and that the reprofiling has tended to be relatively rapid and creditor friendly, compared to past events.(1)
Corporate contrast
As of later 2020, “even the high yield segment had delivered positive returns year-to-date,” she says, “and defaults were almost three times lower in emerging market high yield year-to-date than in US high yield,(2) while recoveries were over double the US high yield year-to-date.”(3) That’s in contrast to 2008, “so this time around may turn out to be the sharpest divergence in emerging market high yield versus US high yield for decades,” says Kurdyavko.
market debt could help in their search for yield, as part of a diversified portfolio.
(1) For example, see Hugh Bronstein et al., Argentina defuses default crisis with ‘massive’ debt deal, Reuters, September 15, 2020: reuters.com/article/argentina-debt-idUSKBN25S4HC; Gideon Long and Colby Smith, Ecuador reaches provisional debt deal with bondholders, Financial Times, July 6, 2020. (2) JP Morgan, JPM CEMBI Diversified HY, as at 30 November 2020. (3) JP Morgan. Recovery rates are issuer-weighted and based on price 30 days after default date. Latest data at 13 October 2020. (4) International Monetary Fund (IMF), World Economic Outlook: A long and difficult ascent, October 2020, p.11: imf.org/en/Publications/WEO/Issues/2020/09/30/world-economic-outlook-october-2020 (5) For example, see discussion in IMF, p.13.
Flexible FX
“While we have seen increasing post-Covid levels of debt, we don’t think this is yet at prohibitive levels for a lot of emerging market economies,” she says, “and local currency markets have become the dominant source of funding for both corporates and sovereigns, reducing the FX liability that you have with hard currency debt.”
However, the team acknowledge there are considerable uncertainties. The IMF has described the prospects for many emerging market economies excluding China as ‘precarious’,(4) and defaults might yet rise significantly if recovery scenarios harden due, for example, to a rockier than expected vaccine roll out, fears of inflation, or policy mis-steps.
Policy performance
“For me the key single determining factor in the performance of emerging markets in 2021 may come down to the policy mix in individual countries,” Kurdyavko says, including “the ability of emerging market countries to manage their fiscal deficits in the lower long-term growth environment likely through 2021 and beyond.”(5)
“That's where this crisis differs: in prior crises, we exited the crisis with less debt and more growth,” she says, “and this time, we're going to exit with more debt and a very uncertain growth outlook.” Emerging markets generally relevered balance sheets a lot less than the developed world during 2020, she says, but leverage needs to remain appropriate.
Somewhat offsetting those dangers, the new US president seems likely to take a more multilateral approach, says Kettle, “so one of the big positives for emerging markets under Biden may be a reduction of the geopolitical risk premium.”
Presidential positives
Vaccine rollout in some emerging markets is likely to take longer than in developed economies and the rollout speed may vary from country to country. “But if the new vaccines start to lessen restrictions on mobility within the next nine months, and we get a little bit of fiscal stimulus at the same time, you could see a bounce in risk and growth-sensitive assets,” he says, “with foreign exchange probably being the most sensitive growth asset within emerging markets.”
This time, we're going to exit with more debt and a very uncertain growth outlook
That view was tested somewhat during the corona crisis turbulence in March 2020, when the team say “the ESG strategy tended to marginally outperform our conventional high-yield strategy, and the damage done to commodity prices was a factor in that.” Conversely, “the conventional fund tended to outperform the ESG fund during the recovery phase.” (See figure below)
Covid-19 has helped reveal both vulnerabilities and resilience in emerging economies. As the world begins a difficult recovery phase, and prepares for lower long-term growth over the next few years, does the asset class require both reappraisal and nimbler, more selective strategies?
Meanwhile, global growth will no longer help to cover up problems such as unorthodox policy, corruption and governance issues. “In a low growth world, we may see more inter-regional or international disputes because everyone has to find someone else to blame,” she says.
The team are largely optimistic but as experienced managers of a fund with a ten-year track record, they know things can change quickly – in world politics, in emerging markets as a whole, in sub-assets, and in individual countries.
New nimble
They are hoping their mosaic team approach and the flexibility of their benchmark agnostic strategy will keep their investing nimble as emerging markets negotiate a new kind of recovery, from a new kind of crisis.
Polina Kurdyavko, Senior Portfolio Manager Anthony Kettle, Senior Portfolio Manager
BlueBay Asset Management
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The BlueBay Emerging Market Unconstrained Bond Strategy
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BlueBay – a fixed income specialist
Source: BlueBay Asset Management
Base currency
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Polina Kurdyavko Anthony Kettle
MANAGERS
20 July 2010
Launch date
UCITS
FUND STRUCTURE
USD651m
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Key Facts
The BlueBay Emerging Market Unconstrained Bond Strategy is a total return strategy that dynamically manages EM exposures through the market cycle. The strategy is actively managed as a portfolio of high conviction positions with flexibility on interest-rate, currency and credit exposures.
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EMD unconstrained - the four pillars of implementation
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BlueBay is an active fixed income specialist structured to deliver outcomes tailored for our clients' needs
BlueBay is a subsidiary of Royal Bank of Canada.
Our investment philosophy is based on our belief that financial markets are inefficient and can be exploited through active management based on high quality proprietary research.
Our investment edge is in our approach and our talent
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ESG
CREDIT
Regular meetings with global policy makers in developed and emerging markets
ESG is fully integrated into research, decision-making and portfolio construction
Regular meetings with company management teams and regulators
Source: BlueBay Asset Management, as at 31 December 2020
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What are the key goals of the BlueBay Emerging Market Unconstrained Strategy?
Polina: The strategy aims to capitalise on our best high conviction ideas across the four key emerging markets’ sub-asset classes (box), while also trying to reduce volatility. That balance has always been the biggest challenge when running high conviction portfolios in emerging markets.
Polina: We see that investors naturally talk a lot about individual stories. But when you are trying to solve not only for higher returns but for lower volatility, you must spend, in our view, at least 50% of your time thinking about portfolio designs that might achieve that lower volatility.
How do you try to resolve it?
Polina: A combination of both. Looking separately at emerging market sub-assets – corporates, sovereign, local currency – can work until you have a catalyst which connects those three, because then correlations pick up.
Does your ability to look across sub-asset types help mainly in portfolio risk management or finding opportunities?
We prefer to conduct what we call a ‘mosaic approach’, where we look at all the assets holistically – we have one team, we don't have three separate teams – to try to understand both how these assets relate to each other and which, in our view, is the best risk-adjusted asset within that set.
Polina Kurdyavko and Anthony Kettle on seeing the bigger picture
Polina: For example, in the pre-Covid world, we’d travel to a country together and look at corporates, sovereign, local currency debt holistically, i.e., look at all the opportunities within a country and try to identify for each individual country which assets offered the best risk-adjusted return, almost being agnostic about which sub-asset class those returns comes from – while remaining wary at the portfolio level of the potential stress correlations. Nowadays there’s lots of video calls!
How does that shape your day-to-day investment activities?
Polina: In some situations, such as when the Covid-19 news became pronounced, and the market starts to be vulnerable to a sell-off, we know that making an adjustment in credit would be costly and wouldn't necessarily reflect our fundamental views on individual alpha stories. But making adjustments to FX means that the book can potentially be well protected on the downside – and hopefully also able to recover quickly in the months to follow.
The emerging markets mosaic
How might that help in practice?
Polina is Head of Emerging Markets and Senior Portfolio Manager at BlueBay. Polina started her career in emerging markets after the Russian financial crisis in 1998 and has, since then, gained expertise across a broad range of emerging market financial assets. Polina joined BlueBay in July 2005 from UBS where she was a credit analyst in EM corporate research. Her role encompassed coverage of EM issuers as well as research support for primary issuance of corporate debt. Prior to this, Polina was with Alliance Capital where she was an emerging markets equity analyst and then moved on to pioneer emerging markets quantitative research at the firm. She started her career in a macro research boutique in Russia. Polina holds an MSc (Hons) in Finance from the People’s Friendship University of Russia, Moscow and is a CFA charterholder.
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We prefer a ‘mosaic approach’, where we look at all the assets holistically
Polina Kurdyavko, Partner, Head of Emerging Markets, Senior Portfolio Manager
Anthony is a Senior Portfolio Manager within the Emerging Markets Team. Anthony joined BlueBay in March 2006 and his primary portfolio management responsibilities include the EM long-short credit strategy, the EM Unconstrained Bond Fund and the suite of EM Corporate long only funds. Prior to joining BlueBay, he held a management position at National Australia Bank. Anthony holds a Bachelor of Commerce degree from the University of Melbourne, a Graduate Diploma in Applied Finance and Investment from the Australian Securities and Investments Commission, and is a CFA charterholder.
The team is not siloed, we're all based in London, because the asset class is so interlinked now
Anthony Kettle, Partner, Senior Portfolio Manager
Anthony: It changes a lot. Our risk parameters are quite broad, and we have the ability to execute shorts (via the use of financial derivative instruments) as well. The range of risks that we can run is much broader because of that short leg. For example, through 2020 into November, in FX we moved from long to being short to being significantly long again.
Does your portfolio change a lot through time as your outlook adjusts?
Anthony: In our view, ESG is something that emerging markets investors should always have been looking at: a lot of emerging market countries and credits rank towards the top level of ESG risk. At BlueBay, ESG is now fully integrated into our processes. We have seen a large amount of issuance in the green bond space as well, so it is certainly a growth area.
Is ESG an increasingly important factor in your analysis?
All of us have input to the ESG team, but the credit analysts and strategists, and the sovereign strategists, work especially closely with the ESG team to form two views: a fundamental view of the issuer’s ESG risk rating; and then our view on the ESG risk score appropriate for the particular investment.
Explore BlueBay’s unique approach to integrating ESG with My-Linh Ngo and Lucy Byrne
Justin Jewell and Andrzej Skiba on both their high yield outlook and ESG integration
Is the outlook sustainable?
Local currency as a sub-asset class is very different from high yield credit in terms of volatility, and therefore when we size the individual positions and look at it in holistic portfolio terms, we need to look at each sub-asset in a different way.
A second difference is transaction costs, which for example are much higher in credit than in FX, so our portfolio turnover will also be different. And thirdly, related to this, liquidity and our ability to reposition are also different. When we construct the portfolio, we take those three points into account.
Anthony: Often we'll have a portfolio manager, a sovereign strategist and a corporate strategist, a financial analyst, all bringing different perspectives. The team is not siloed, we're all based in London, because the asset class is so interlinked now: you can't understand Brazil without understanding that country’s oil production sector, for example.
Polina: That’s not to say that we rotate the entire portfolio because you always have some structural trades with, say, a 12-18 month time horizon.
Anthony: Also, we won't simply run shorts as a hedge. Running shorts as a hedge we think is certainly helpful, but we will have shorts on the book as alpha trades as well. We may have certain shorts we've been running for 6-12 months in the FX space, for example, which are alpha trades because we think, regardless of market conditions, these trades can work out.
Provided the results do not ban us from looking at an investment, we then try to marry this ESG view with the valuations in the market. Is the ESG risk already discounted in the price, or not? That investment call is taken on the desk, but our close interaction with the ESG team helps us to form the fundamental views – and we get regular updates from the ESG team at the industry sector level too, e.g., on what’s been happening in the oil and gas space over the last month.
Emerging market debt: Four main sub-asset classes
• USD-denominated sovereign debt • USD-denominated corporate debt • Local currency-denominated sovereign debt • Local-currency-denominated corporate debt
We see that investors in emerging markets usually combine different asset classes without enough reference to their very different volatility regimes.
