Emerging-Market Bond Values Too Frothy for Fidelity's KhanBy
Khan is cutting developing and U.S. high-yield note holdings
He’s ‘constructive’ on Brazilian and Mexican corporate debt
Emerging-market bonds have already rallied enough for Peter Khan.
With their yield premium over U.S. Treasuries near the lowest since 2014, the fixed-income manager at Fidelity International Ltd. is playing a waiting game.
Khan, whose Global Income Fund has beaten 81 percent of its peers with a 2.4 percent return this year, said he’s been reducing his allocations to developing-nation notes and U.S. high-yield corporate debt. The London-based investor, whose company manages $67 billion of fixed-income assets, said this will give him more flexibility.
“We know from experience as credit-market investors that when valuations do get stretched we need to be more careful and more guarded in terms of the way we take exposure,” Khan said. “We want to be in a position where we have liquidity to invest when volatility arrives.”
Below are questions and answers from an interview with Khan:
Why have you been reducing your bond holdings?
- “The valuations that we’ve arrived at on the basis of expectations of future growth or diminishing future defaults have priced in most of the optimistic outcomes we can reasonably expect in the next 6 to 12 months. That’s not to say we have become very bearish on the asset class. There are a lot of good reasons for caution out there in the market at the moment.”
- “People have gotten a bit ahead of themselves, and it’s easy to do that when central banks have conditioned the global investor community to expect a persistent and deep backstop every time that there’s a little bit of a wobble or nervousness about growth or systemic risk. Your friendly local central bank is there with a big bucket of cash.”
- “There are increasingly binary outcomes approaching us in terms of growth. We’re still waiting for the real follow-through where it’s really important in terms of wage growth and increasing capex, in the U.S. economy in particular, to help take us to a new phase of expansion. A lot of money has been invested in anticipation that all these good things are going to happen.”
How are you navigating these risks?
- “There’s better risk reward, better overall compensation in selected emerging-market exposures. The valuations in emerging markets at the aggregate level have probably pushed beyond where the reality is on the ground in terms of growth and the actual credit cycle. There’s not as much exuberance priced into emerging markets, in my opinion, as there is in U.S. high yield.”
- “If valuations continue to reflect optimism, more growth is priced into the markets. I think the risk reward for an investor with an intermediate-term horizon would be better suited to shift into cash and government bonds.”
Where do you see opportunities?
- “I’ve got a modest overweight on emerging markets. Broadly speaking, the amount of credit exposure I’m taking in my portfolio, I’ve brought it down. We’re much more focused on those names where we think they have capacity, flexibility to ride through some periods of uncertainty.”
- Khan said he’s “constructive” on Brazilian and Mexican corporate bonds, and favors a select group of notes from China and Indonesia, but is less into companies in India and property firms in China.
- “We’ve seen substantial value created in Latin America by the uncertainty from Trump, but also from regional and domestic political uncertainty and ongoing investor concern about corruption and reform starting with Brazil.”
- In Brazil, “you would have commodity producers, who have a low-cost, high-quality mix in their overall business portfolio that have access to persistent demand from China.”
- “There are high-quality Mexican credits that are competitive multinationals. Many of them --- the material sector for example -- are poised to benefit from ongoing growth in North America.”