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Top Fund Manager Sees Emerging-Market Debt Upswing Through 2022

  • Western Asset Management favors debt rated BBB, local notes
  • Emerging markets now ‘less prone to panic selling,’ Lian says

Developing-nation debt will be one of the most lucrative bets over the next three to five years as growth accelerates from Indonesia to Brazil, according to one of the sector’s top investors.

Chia Liang Lian, the head of emerging-market debt at Western Asset Management, sees the opportunity to scoop up cheap assets from high-yield nations as current-account deficits shrink and oil rallies from its January 2016 low. The Western Asset SMASh Series EC Fund he helps manage has topped 99 percent of peers this year and 98 percent in the past five years.

“Emerging markets are looking well positioned,” Lian said in an interview from Pasadena, California. “From time to time, this asset class is vulnerable. But over three to five years, we think drivers of global growth are good for EM.”

His bullish stance comes amid lofty asset prices across developing nations and increased skepticism about their sustainability as the Federal Reserve pulls back on stimulus. But Lian sees these countries delinking from industrialized counterparts as central banks from Peru to India reduce borrowing costs amid slowing inflation. This makes locally-denominated notes “very attractive.” He also favors hard-currency bonds rated BBB such as those from Colombia and Indonesia.

Here’s what else Lian had to say about emerging-market investments:

What’s changed since the 2013 taper tantrum?

  • "The taper tantrum flushed out short-term investors, so you got an investor base with a long-term horizon, which creates a situation where the asset class is less prone to panic selling."
  • “The worst is behind us” now that investors have accepted rising borrowing costs in the developed world, geopolitical tensions in Europe have eased and oil prices have stabilized.

What’s attractive about credits rated BBB?

  • The fund manager sees better spread compression for emerging markets versus developed markets in those credits relative to debt rated A or above.
  • Indonesia has “one of the best administrations” and “tremendous” labor potential. “We’re only seeing the beginning of a very positive medium-term story, which could bring the country to an even higher rating.”

Where are you most overweight and underweight?

  • Biggest overweight positions are in Indonesia, Argentina and Brazil, while largest underweight allocations are in dollar-denominated Chinese credits, the Philippines and India.
  • Argentina is a “re-rating story” after 15 years of challenges. Still, the situation there could get worse before it gets better.
  • Brazil has “gone through a baptism by fire following the taper tantrum with oil challenges and political challenges related to” a sweeping corruption case.
    • In the 2018 presidential elections, he prefers an “understated candidate with policy pragmatism” over someone who “over-promises and under-delivers.”
  • Although a “hard landing” is unlikely in China, valuations look stretched.
  • The fund has trimmed holdings in the Philippines from its large overweight over the past four years, while India is also underweight as U.S. dollar debt is limited.

What else do you like in the sector?

  • Lian has overweight positions in frontier markets including Ghana, Sri Lanka and Honduras. He sees supportive fundamentals boosted by additional funding sources such as the IMF.
  • He also says the fund has recently become more overweight high-yield debt.
  • Declining geopolitical concerns and stable oil prices make Ukraine and Ecuador more attractive.
  • The fund is zero weight in Mozambique and has trimmed exposure to Venezuela over the past nine months amid “deeply concerning” political developments. A debt restructuring for the sovereign or state oil company “wouldn’t surprise us,” he says.
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