LONDON WINTER FORUM EXPLORES QUEST FOR VALUE IN VOLATILE MARKET
The quest for value in turbulent times was one of the main themes at EMTA’s Winter Forum, held on Wednesday February 27, 2008 in London. The event, which was hosted by JPMorgan, attracted over 150 EM professionals.
Will Oswald (JPMorgan) moderated a discussion of leading sell-side analysts, and asked his co-panelists to compare EM credits to their G-7 counterparts. Anne Milne of Deutsche Bank, the panel’s corporate debt expert, responded that each sector in EM debt could compare differently to US and European counterparts, and that often there could be regional differences within the EM world. For example, Latin steel companies were generally less attractive than similar US issues, while Asian steel maker debt generally offered better value than their US comparables.
Calling a spade a spade, Arnab Das (Dresdner Kleinwort) noted that "EM is not the safe haven that some are calling it" and the notion of "decoupling is nonsense". He recognized that sovereign bonds are a diminishing asset class and suggested that corporate debt is becoming a proxy for sovereign performance. "There is not a natural home for EM corporates; they don’t really fit into High-Yield or High-Grade very easily," he opined. Das noted that, at least for now, there is not a lot of money benchmarked against EM credit indices. "The problems in the US are far from over, and the chances of a US recession are high and rising," Das warned would-be investors in the US market, while specifying that he was not yet forecasting a recession.
Credit Suisse’s Kasper Bartholdy expressed concern that the market had not fully priced in global economic conditions. He saw G-3 corporates as offering value but cautioned that there "are likely to be better entry points."
Oswald asked if it was too simplistic to link countries with current account deficits to underperformance in the recent market sell-off. Das replied that recent performance could not be blindly tied to a country’s current account balance, and advised investors to think in terms of those countries which are "small, open and exposed vs. those which are large and protected." Countries with large reserves and large economies will be OK if the US downturn is short and mild, according to Das, although even they could suffer serious consequences if the decline in US growth was deeper and lasted for more than six quarters. Bartholdy agreed that, if assumptions about a mild recession are wrong, "EM experts will suffer".
Bear Stearns’ Tim Ash commented that, although current focus has been on the US, eventually the market will turn its eye to European growth, especially for emerging European markets. He also questioned the strength of the commodity markets in light of the US slowdown and raised concerns that, if equity markets were to be dragged down by the US, commodity pricing could follow.
Sell-side recommendations varied widely. Ash recommended investors buy protection on Eastern Europe, as well as going long VTB, Gazprom and Naftogaz bonds. He recommended Russian telecoms as well as a defensive position. Das favored investments in the Brazilian real, Russian ruble and Chinese yuan while avoiding the South African rand. Milne seconded a buy on Gazprom, while also picking Lukoil and "for those who have the stomach" Argentine utilities. Bartholdy urged investors to consider Kazakh sovereign and bank paper as well the Nigerian naira, Colombian peso and Russian ruble, for those with patience.
Ashmore Investment Management’s Jerome Booth initiated the event’s investor panel by asking for each speaker’s assessment of the current market environment. Michael Balboa (Millennium Global Investments) expressed skepticism that the US could avoid a recession, while Susanne Gahler (F&C Investment Management) acknowledged that she was avoiding corporate debt altogether, and was not convinced of liquidity in local markets in times of turbulence.
Focus Capital’s John Cleary remained optimistic on the long-term outlook for EM debt while expecting short-term volatility, but noted that "you can get higher yield, or higher liquidity, but not both". Booth himself stressed long-term technical factors which support EM debt prospects. "People are no longer falling off their chairs when pension fund managers are told they should have 35% of their holdings in EM," he observed.
Turning towards more specific topics, Gahler stated "the jury is still out" as to whether a technical default would occur on Venezuelan debt. While this was not the likely scenario, Gahler cautioned that Venezuela’s creditors must "remain nimble on their feet." An oil price drop could cause rapid changes in Venezuela, and Gahler considered it one of the highest risks in the asset class.
Balboa added that one cannot discount political risk in Venezuela. He admitted to having briefly turned bullish on Venezuela in the aftermath of the recent referendum’s defeat, speculating that it could augur the end of the Chavez administration. Balboa admitted to once again being a bear, concerned that with less public and military support, President Chavez might resort to "pick fights" as many "desperate politicians" have done before him. Cleary agreed that a new era in Venezuela might be possible. "If you are seen as infallible but then start losing…" he commented.
As for commodities, Gahler forecast lower prices including oil by year-end (though no "major corrections") while expecting agricultural pricing to rise. Cleary commented that in light of the current volatility, "cash is not a bad place to be." He added that protectionism will likely be a growing theme.
Balboa noted that the regulatory regime that permitted structured financing to flourish was being re-accessed and might never be the same. "You don’t want to be long in anything that was created between 2002 and 2006," he added. Panelists had different views regarding overall market appetite, with Gahler observing that there were "enormous difficulties in reading the data".
While Booth opined that pension funds and central banks were "massively underweight" in EM assets, Balboa countered that, "having been burned in various products seeking yield, pension funds are unlikely to move seriously into EM". John Cleary noted soberly that "If the credit cycle really has changed globally, it will be very difficult with much wider credit differentiations".
Before adjourning for a cocktail reception, panelists made a number of recommendations. Gahler saw little of interest in external debt, citing liquidity, but "would take bets" on the Brazilian real, Polish zloty and Turkish lira. Cleary saw value in Asian corporate bonds and some local currencies but agreed that external debt currently offers value. Balboa sought countries which have been excluded from the previous credit boom such as Tanzania, Cote d’Ivoire and Sri Lanka.