Aviva Storms Into Risky Frontier Debt as Trade Jitters Ease

Updated on
  • Money manager says selloff has made EMs attractive once more
  • Frontier market favorites include Sri Lanka, Kazakhstan, Ghana

A few weeks ago, Aviva’s emerging-market debt funds were cutting back on risk amid rumblings of a global tariff war. Today? They’re wading into some of the world’s most speculative investments: frontier market bonds.

The change of heart comes amid signs of easing trade tensions between the U.S. and China, as the two countries appear to be working toward a deal instead of a deepening confrontation. President Donald Trump’s announcement last week of tariffs on up to $60 billion of Chinese goods prompted a selloff in global risk assets, bringing the S&P 500 Index to its biggest weekly loss in more than two years and inspiring retaliation from Beijing.

It also brought a welcome pause to a two-year rally in developing-market assets, creating fresh buying opportunities, according to Liam Spillane, who helps manage $13.8 billion as the head of emerging-market debt at Aviva Investors Global Services.

“A few weeks ago, we had a short-term concern because of headline volatility related to trade rhetoric alongside a greater willingness of the market to engage with higher rates and inflation in the U.S.,” said Spillane. “We have already come out on the other side. The risk-reward equation has become favorable again.”

At the height of concerns over a potential trade war, Aviva eliminated some of its short dollar positions, made bearish bets on South Korean assets versus the Japanese yen and moved from overweight to neutral on local-currency bonds.

With tensions abating, Aviva is back in the market for risk. This time, however, the $446 billion money manager is being more selective. Rallies in uncorrelated assets spurred by perpetual capital flows are a thing of the past, according to the firm. Taking its place: a two-speed market where volatility creates stark divisions between winners and losers.

In the foreign-currency bond market, Aviva is avoiding extremes. On one side, it places countries like Poland, Philippines and Peru, where risk premiums have narrowed so much as to make the bonds virtually “uninvestable,” according to Aaron Grehan, a London-based money manager at the firm. On the other side are higher-yielding bonds that it sees as most at danger from rising volatility.

“We are now focused on mid-beta markets,” Grehan said. “We are avoiding low-spread markets like central and Eastern Europe, as well as parts of Asia, but we are also cautious on high-yield names.”

Two-Speed Market

The bond rally has left spreads in some nations too low, Aviva says

Source: JPMorgan

Aviva’s favorite bets in the dollar-bond segment are Egypt, Ukraine, Paraguay, Argentina and corporate bonds in Brazil.

The risk premium for emerging-market sovereign dollar bonds over U.S. Treasuries widened 3 basis points to 304 on Thursday, according to JPMorgan Chase & Co. indexes.

When it comes to local-currency debt, Aviva is driving deep into frontier territory. The money manager is building a basket that includes Sri Lanka, Uruguay, Kazakhstan, Ghana and Nigeria, on the theory that increased domestic ownership of these bonds will make them less sensitive to global market swings.

On the other hand, more mainstream emerging markets with greater foreign ownership -- such as South Africa, Turkey and Brazil -- could face whiplash from a Federal Reserve interest rate increase or a trade war.

While the wider investing world has always looked at frontier markets as the riskier end of the developing world, they can actually be safer asset-allocation bets, according to the firm. In fact, Spillane said he expects frontier markets to account for 10 percent or more of Aviva’s portfolios as they grow in size and investor acceptance.

“As long as you get your fundamental story right, the smaller and less-owned markets offer an interesting proposition,” he said. “They offer attractive yields and provide an element of diversification.”

(Updates EM risk premium in the 10th paragraph.)
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