Transcript
Speaker: This is HSBC Global Viewpoint, your window into the thinking, trends and issues shaping global banking and markets.
Speaker: Join us as we hear from industry leaders and HSBC experts on the latest insights and opportunities for your business.
Speaker: Thank you for listening.
Speaker: My name is Murat Tulgan.
Speaker: I'm the global head of emerging markets research.
Speaker: Let me introduce the panel first.
Speaker: So we have Mr. Michael Story from PIMCO Group.
Speaker: He's the senior vice president and emerging market product strategist.
Speaker: I have Mr. Uday Patnaik, who is the head of emerging markets debt at Legal and General Investment Management.
Speaker: I have Mr. Devon Kalou.
Speaker: He's the global head of public markets and global head of equities in Aberdeen.
Speaker: We have Mr. Praveen Jagwani from Unit Trust of India.
Speaker: Internationally, he's the CEO and solely focused on investments in India.
Speaker: So gentlemen, thank you very much for joining me.
Speaker: So let's kick off the panel.
Speaker: We have a relatively short time to talk about emerging markets, which is a massive topic.
Speaker: But let me kick off from the beginning, sort of the top down, big picture, global macro environment.
Speaker: I've been doing this business for about 25 years in various guises and last eight years and I'm a strategist.
Speaker: It's fair to say, at least from my perspective, this is probably the most challenging or as challenging as it could get in terms of the external backdrop from slowing global growth, slower China growth to rising inflation, higher global rates, withdrawal of liquidity.
Speaker: Stackflation is a sensational headline.
Speaker: We don't get it very often.
Speaker: We tend to brand it more like a worsening in EM's growth inflation mix.
Speaker: which is not great.
Speaker: And I think that's also relevant for developed markets as well.
Speaker: It's not only global cost of funding is rising, but global liquidity is also falling.
Speaker: And we got lots of volatility across asset classes, a stronger dollar and volatile commodity markets.
Speaker: So clearly no major anchor for EM externally, if I dare to say, if anything, the drags are getting very, very powerful.
Speaker: particularly growth where the financial conditions have been tightening for EM for some time.
Speaker: The Fed started hiking rates in March.
Speaker: A lot of emerging markets were hiking interest rates for more than a year.
Speaker: Obviously, falling equity markets and credit growth getting slower, if not negative in certain cases, tightens financial conditions.
Speaker: not a great picture for future growth.
Speaker: And on inflation, I'd say EM is particularly vulnerable when it comes to the staple subsistence items, especially food and energy, because they have a much larger share in EM's consumption basket compared to the developed markets, especially food, which occupies somewhere between 20 to 45%, depending on the country.
Speaker: And it's quite sticky.
Speaker: But not everything is in doom and gloom.
Speaker: I'd say, you know, contrary to the fundamental backdrop, the technical picture is actually pretty supportive for EM, which I mean the valuations, because now we're talking about stagflation in the context of developed markets, but EM has been undergoing stagflation influences.
Speaker: for nearly a year, pretty much since the second half of this year.
Speaker: And if you look at the pricing, if you look at the spread on external data, if you look at local markets rates, if you look at the equities like universal price earnings ratio, earnings yield, these are back to 2018 levels.
Speaker: Last time we saw this double dammy of Fed hiking more than expected and balance sheet reduction.
Speaker: So I'd say valuations are quite compelling actually, and in certain cases really, really compelling.
Speaker: And then the positioning has been reduced significantly pretty much across the board, more so for local debt.
Speaker: Every quarter HSBC conducts what we call an emerging market sentiment survey, where we canvass views of institutional investments from all walks of life, asking them questions about market and macro trends, but also asking cash levels and how they're intended to use that cash.
Speaker: And it's been five quarters that cash levels have been constantly going higher.
Speaker: In the last survey that we released in March, 25% of the investors have more than 10% cash in their portfolio as an issue of asset management.
Speaker: That is a very high number.
Speaker: So what I'm really trying to say, we got a super challenging, fundamental, external picture.
Speaker: We got a supportive, technical picture.
Speaker: How do we square this?
Speaker: Well, from our side, our humble view is it's not top-down.
Speaker: Top-down is very difficult.
Speaker: We look at bottom-up opportunities.
Speaker: We try to side...
Speaker: still countries who are the beneficiary of elevated commodity prices, commodity producers and exporters.
Speaker: But that by itself is not enough.
Speaker: We also would like to see an effort to get ahead of the inflation curve, to arrest inflation pressures, prudent policies, be it monetary tightening,
Speaker: in the case of Latin American countries, for instance, which have been rather aggressive in their rate hikes and for quite a long time, or be it responsible fiscal policies, like in the case of GCZ countries, where they're actually rolling out fiscal reform, tax reform, VAT, corporate tax, et cetera.
Speaker: Those are our preferred regions, GCC in particular, more perhaps for equities and credit and then some effects and maybe local markets at some stage in Latin America.
Speaker: But I have to say, not spoiled for choice.
Speaker: It is a difficult backdrop and we try to be a lot more selective and try to take calculated EM risk.
Speaker: So why don't I now turn to Michael.
Speaker: who actually has a very broad remit across the whole fixed income spectrum.
Speaker: And Michael, if you could touch upon sort of your general approach to the asset class, how do you rate local versus external?
Speaker: How do they stack up?
Speaker: Liquid versus illiquid, you know, private credit, maybe if there's time on frontier markets.
Speaker: So lots to go through, Michael, over to you.
Speaker: Thank you very much.
Speaker: This is a very difficult backdrop.
Speaker: And a lot of times we think in terms of push versus pull factors in EM, the pull factors that are those that are kind of pulling capital into our space, the endogenous factors, and then there's the push factors that are exogenous from outside the asset class.
Speaker: And obviously allies are in the Fed, allies are on inflation and other kind of global monetary condition metrics.
Speaker: So it's a tough backdrop, but we would completely agree the valuations are very attractive and some of the structural secular
Speaker: Technicals also look very attractive, but this is an acute moment.
Speaker: We're all going through an acute moment.
Speaker: I think in the external space, correct me if I'm wrong, but I think this is maybe the third largest drawdown in the history of the asset class.
Speaker: We can go back to the global financial crisis.
Speaker: We can go back to Asia in 1997, a very, very different landscape then versus now.
Speaker: And yet we've got this massive sell-off.
Speaker: driven by rates, driven by repricing of interest rates, inflation, and global monetary conditions.
Speaker: I think one of the questions that we get a lot is, should we invest in local or should we invest in external?
Speaker: It's a very tough question to get right.
Speaker: In fact, I would say that making that call is inherently a lower Sharpe ratio type of decision.
Speaker: It's a very difficult one to get right.
Speaker: And of course, the last 10 years, maybe even longer, has made that decision even more difficult because local...
Speaker: has been on the back foot.
Speaker: We've seen a dollar bull market for 10, 11 years now.
Speaker: We went from strength to strength when COVID hit and the dollar benefited from a safe haven bid.
Speaker: And so that's something to watch out for.
Speaker: But I would say that generally, we're pretty cautious on local at the moment.
Speaker: We're quite bullish on external, although longer term, I think there's a lot of value to be had on the local side.
Speaker: External is an easy one.
Speaker: You can kind of look at that as a complement, a diversifier to credit, US corporate credit, European corporate credit, securitize.
Speaker: There's been a lot of money flowing into this space for a very long time.
Speaker: And it's a very easy way to complement that or diversify
Speaker: some of the concentrations.
Speaker: It's rare to find an asset class that does not have a trade-off.
Speaker: Normally, if you want to diversify, there's a yield give.
Speaker: Looking at EM external is one of those rare opportunities not to give yield and deconcentrate.
Speaker: On the local side, I think you have to lean in more on the diversification angle.
Speaker: There's a lot of idiosyncrasies.
Speaker: If you look at the 20, 25 countries in the space, they all move quite independently.
Speaker: Even in an environment now where there's kind of this global exogenous shock on inflation and supply chain disruptions.
Speaker: But there is a kind of a lower co-movement.
Speaker: But ultimately, you do need EM currency appreciation to justify the vol.
Speaker: And we have not had that for quite some time.
Speaker: So that's something that we'll be looking for.
Speaker: When we think about asset allocation, I would suggest that there's a better way than thinking about local versus external.
Speaker: That's kind of the top level question.
Speaker: I think the better response is to unbundle or unpack the different risk factors that are embedded in these different asset classes.
Speaker: On the external side, of course, the main risk factor is spread, compensation for credit risk, and then there's US duration.
Speaker: And on the local side, you've got two risk factors that are really driving things, it's currencies and then it's duration, but local duration, very different than the duration on the external side.
Speaker: And the way we would rank order these, and if you think in kind of a terms of a risk parity approach to constructing a portfolio is we would put local duration at the top of the list.
Speaker: It's a very interesting risk factor.
Speaker: I think one of the most underappreciated risk factors that are out there in global fixed income.
Speaker: There are EM countries now that can play the same role that gilts or bunds or US treasuries can play.
Speaker: Bad things happen and there's a rally, not a sell-off.
Speaker: So not just a yield generator, but some kind of a hedge against downside markets.
Speaker: And so it's a really interesting risk factor to consider and we would lean into that.
Speaker: But again, you have to unbundle that from a local bond that has currency exposure as well.
Speaker: Next in line would be spread.
Speaker: Right now, spreads look really interesting.
Speaker: But again, there's this complementary effect that is quite interesting.
Speaker: And then last on the list is currencies.
Speaker: And that's a difficult one to get right.
Speaker: Idiosyncrasy, I think there's a lot of interesting opportunities.
Speaker: But again, it's been a very difficult backdrop.
Speaker: One of the things that we've been doing more is looking at lending opportunities along the liquidity spectrum.
Speaker: I think there's been a flood of capital, as we all know, private credit in the US, private credit in Europe.
Speaker: This has been a phenomenon for a very long time.
Speaker: We've not seen the same phenomenon in emerging markets.
Speaker: There is a credit constraint in a lot of countries, not all of them, of course, but there is a credit constraint in a lot of countries, and it's a large effort to intermediate illiquidity.
Speaker: in emerging markets relative to the US and relative to Europe.
Speaker: And so we are moving down the liquidity spectrum and designing vehicles for that.
Speaker: But EM overtook the US as the single biggest pool of credit in the world a number of years ago.
Speaker: It continues to expand.
Speaker: for good reasons, for some less good reasons, but it's the biggest pool of credit in the world now.
Speaker: And I think there's a major kind of miss when you're not considering searching out premiums for illiquidity, which is very orthogonal, uncorrelated to the other risk factors that I mentioned, currencies,
Speaker: duration spread and embedding that in the portfolio.
Speaker: So I think there's a really interesting area there that we could maybe investigate further.
Speaker: Thanks very much, Michael.
Speaker: I think that sets the stage very neatly for the broader fixed income world.
Speaker: I appreciate that.
Speaker: And perhaps as we stay in fixed income, maybe we go into a little more specifics with Uday, perhaps touching upon the picture on external debt, high yield versus RG, supply versus demand across the regions.
Speaker: And how do you think the current US Treasury Board of Tility is spilling over to EM?
Speaker: Thank you Uday.
Speaker: Actually, we're positioned very similarly that we prefer hard currency to local currency, given our view on the U.S. dollar, which is still positive.
Speaker: So I've been investing in emerging markets, fixed income for about 30 years.
Speaker: A lot of people think of this asset class as this homogenous asset class, but it isn't.
Speaker: But in my 30 years, what I would say is the opportunities we're seeing today are fairly unique.
Speaker: I mean, we haven't seen these opportunities since March, April 2020, since COVID.
Speaker: In fact, if you look at the external, the JP Morgan sovereign index, the MB index, the yield is
Speaker: 25, 30 basis points away from where we were during COVID, peak COVID on that index.
Speaker: And the spreads over the last 12 years are about the second or third highest, just second to the COVID period.
Speaker: So the opportunities are dramatic from an investing standpoint.
Speaker: Now, there are a lot of ways you can do this.
Speaker: And we have a lot of themes that are running through our portfolios.
Speaker: So number one,
Speaker: We have been underweight duration for quite some time.
Speaker: That said, we're in the process of neutralizing our duration underweight, and we can maybe talk about inflation later.
Speaker: But number two, we have a preference for credits that are commodity exporters, whether it's sovereigns or corporate.
Speaker: So countries like Angola, for example, where debt to GDP two years ago was 130 percent.
Speaker: By the end of this year, expected to be about 55 percent.
Speaker: We like reform stories like Oman, again, where you've got the oil impact.
Speaker: You also have declining debt and strong reform measures.
Speaker: Other reform stories, for example, in India, renewable energy companies, which are offering attractive yields, steel companies in India.
Speaker: Some commodity producers in India, like Vedanta, as an example.
Speaker: Within the IG space, we have a preference in LATAM for Mexico versus underweights in select countries like Peru due to the politics, underweight in Uruguay, for example.
Speaker: So you can really pick and choose now.
Speaker: And I'll give you an example.
Speaker: The yield, we have a short duration fund, is one of our many strategies.
Speaker: dollar denominated, duration of three years, a yield of about 8.75% in dollars.
Speaker: This is rare.
Speaker: I mean, this happened once.
Speaker: We've been running this strategy for seven years.
Speaker: This happened once before for about two months during COVID.
Speaker: But you can today buy oil exporter names like Nigeria, one-year debt, dollar-denominated debt in Nigeria, right, where you have external debt to GDP under 20%, yielding about 8%.
Speaker: Now, why do these opportunities exist?
Speaker: The reason is, is the environment when you have financial conditions tightening globally, you have the type of rates volatility that we're seeing, for example, in the move index, equity vol, currency vol, liquidations, clients redeeming, you get these type of opportunities.
Speaker: And this is the situation we're in.
Speaker: But from an investing standpoint, when I look at these opportunities and you do the bottom up, Nigeria doesn't need to come to the markets over the next year.
Speaker: And I'm getting 8%.
Speaker: I'm buying Mexican financials, right?
Speaker: Investment grade rated financials, sub debt, callable in the next two months, yielding 7.5% to call.
Speaker: The number of opportunities geographically dispersed
Speaker: High yield, mostly some investment grade is just fantastic right now.
Speaker: But what I would say is if you have your bottom up right, if you have a fund yielding 8.75%, it's well diversified, you're doing your analysis, you can let this thing just roll off.
Speaker: Perfect.
Speaker: Thank you.
Speaker: Let's go to the equity work and start with Devin.
Speaker: Let's get his views.
Speaker: How do you see the asset class?
Speaker: Where are you on the debate value versus growth?
Speaker: How do emerging market equities stack up against developed market equities and any other topic that you might find relevant?
Speaker: You see China, Asia is a big part of the index and commodity stories.
Speaker: So thank you.
Speaker: A few things that I would highlight.
Speaker: When you look at emerging markets today, there's three big factors I think that people worried about.
Speaker: The first and most pressing one is the rise of US interest rates and inflation.
Speaker: And there, there's the scramble, it would appear, for central banks to try and tackle inflation.
Speaker: And as a result of that, you've seen a stronger dollar and indeed a rising cost of capital for lots of emerging market countries and indeed companies.
Speaker: And that's a big issue which is currently being confronted.
Speaker: The second one is Russia and the impact that's had with regard to commodity prices, but also economic growth within Europe and more broadly or more longer term.
Speaker: whether or not it changes the thinking about what is the risk of emerging markets.
Speaker: And then the third one that we see is China.
Speaker: And with regard to China, I suppose you could break it down crudely into two bits.
Speaker: The first is this issue around COVID and what appears to be this poor handling of COVID.
Speaker: Although in terms of number of deaths, some people would argue it's a good handling of COVID, but that has consequences for supply chains, that's had consequences for Chinese growth.
Speaker: But the other element within that has been the rather lackluster response by the People's Bank of China in terms of dealing with the slowing growth.
Speaker: Certainly expectations were that they would be more accommodative or certainly push the vote out a bit in terms of trying to get the economy going.
Speaker: So all those reasons are reasons why people are currently pretty negative on emerging markets.
Speaker: So I suppose when you're talking about the emerging markets versus developed markets, more often when you see those sort of backdrop, that risk of backdrop, developed markets tend to do better versus emerging markets.
Speaker: And certainly that's true for the US market.
Speaker: So it's interesting then that when you look at year-to-date performance, there's not a lot in it.
Speaker: There's not a lot in it in terms of the relative performance between many of these markets.
Speaker: And I think
Speaker: From an emerging market perspective, I would say there's a few things which you probably need to just bear in mind.
Speaker: We talked a little bit about valuations.
Speaker: I mean, valuations are pretty compelling when you look at emerging markets today.
Speaker: So relative to their 20-year history, they're at lows versus developed markets, whether you're talking about China or whether you're talking about emerging markets more generally.
Speaker: But the second thing, which perhaps needs to be remembered, is that over the next 12, 18 months, there's going to be significant interest rate rises in developed markets.
Speaker: In contrast, in China, you're probably going to see flat down.
Speaker: And that's a really important point because that means that potentially China was a counter cyclical relative to many of the developed markets or developed market economies that we can see.
Speaker: And that's an interesting point because obviously China is today such a large component of emerging markets.
Speaker: But there's a third thing, which I think we've seen as well come out in space, which is that emerging markets are not homogenous.
Speaker: When you look at emerging markets, actually, there's some really strong stories.
Speaker: You can talk about some of the moves in Latin American countries and indeed companies, as indeed in the Middle East and indeed India.
Speaker: You've begun to see, again, people refocusing on emerging markets on the fact that it's a broader story than China.
Speaker: There's lots of interesting things going on there, and I think we need to remember that.
Speaker: So from my perspective, I think as risk off occurs, you probably want to be more skewed towards developed markets.
Speaker: But there's a compelling reason, I would argue, for why you want to look more at emerging markets going forward over the next 12 to 18 months.
Speaker: The last thing I would say is around the issue of ESG.
Speaker: There's been a whole heap of regulations in Europe in terms of the focus of funds and sustainability and the like.
Speaker: And one of the things, or a couple of things that I think have worked just bear in mind, is that emerging markets have a really important role to play in the sustainability agenda.
Speaker: Whether that's supplying the commodities to electrify the world in a different way, whether that's them changing their mix of how they source power and build up new grids, whether that is with regard to the opportunities of companies which are in emerging markets, exporting and developing in the rest of the world.
Speaker: So from an ESG perspective, quite often when we look at emerging markets, people will talk about governance, they will talk about macro risk of say Russia or other places.
Speaker: But actually, what I would argue is that from an ESG perspective, you cannot be a sustainable investor without allocating capital to emerging markets.
Speaker: Perfect.
Speaker: Well, thank you very much, Devin.
Speaker: That sets the stage also for equities very well.
Speaker: So perhaps we can finish off with a very important emerging market economy, India, and go to Praveen.
Speaker: So Praveen, India shows up in all of our long-term research as the country that jumps most in global leadership board in terms of nominal GDP, GDP of capital, so great future potential.
Speaker: but perhaps some volatility in the near term.
Speaker: I mean, growth out is not that bad, but inflation is high and the RBI made a surprise rate hike.
Speaker: So how do you see the macro backdrop from here and investment environment, fund flows, equity market performance?
Speaker: So what's the article in India?
Speaker: Thank you.
Speaker: Every dark cloud has a silver lining and it's my privilege to talk about India, which really is bubbling up as a silver lining to all the doom and gloom that you see globally.
Speaker: There's no talk of stagflation in India.
Speaker: There's certainly no talk of recession in India.
Speaker: India remains the fastest growing global economy right now, and for a good reason.
Speaker: And I'm distinguishing between the economy and the stock market.
Speaker: India is in the best shape it has been in the last decade.
Speaker: And I won't say it's by design.
Speaker: It just so happens that just before the pandemic hit, India conducted a series of structural reforms which have been transformational.
Speaker: And historically, whenever any country engages in this kind of reform process, for the next few years, growth is geometric.
Speaker: And we would have seen that kind of geometric growth in India had we not been stymied by the pandemic.
Speaker: So you forget about 2020 and 21, 19 and 20.
Speaker: And here we are with 2021 being the first great year where India's growth metrics are all at the highest they've been in the past decade.
Speaker: And I mean, instead of me going through each macro variable, I would simply refer to the IMF forecast for GDP growth, which says that the world this year and next is going to go at 3.6%.
Speaker: All European countries, the best case is 3%.
Speaker: France is 2.9%, Italy lower.
Speaker: China is going to grow at 4.4%.
Speaker: India is going to grow at a whopping 8.2%.
Speaker: So there you have it.
Speaker: That's why it's a silver lining.
Speaker: It reminds me a bit of Forrest Gump.
Speaker: Everyone's going this way, Forrest Gump's just running straight shooting.
Speaker: And that's because of the confluence of factors.
Speaker: Two domestic factors and one global.
Speaker: The two domestic factors are, we got 1.4 billion people buying shampoos and sandals and bicycles every single day.
Speaker: So the consumption boom in India is off the charts and it's gonna continue.
Speaker: So domestic middle-class consumption has always been there and you can't take it away from the country.
Speaker: The second domestic factor is the reforms.
Speaker: Seminal structural reforms, goods and service tax, insolvency bankruptcy, now the production-linked incentive.
Speaker: Our Prime Minister Modi, he has a penchant for running the country like a CEO.
Speaker: He gives companies targets.
Speaker: You meet this target, I give you a tax discount.
Speaker: And people, of course, they rise to the occasion.
Speaker: As a consequence, India has become the biggest exporter of mobile phones for Samsung and Apple.
Speaker: Would you have thought that?
Speaker: So in the last couple of years, the reforms have played a critical role in positioning India as a fast growth economy.
Speaker: And finally, the third factor, which is more global.
Speaker: I think we heard about push and pull factors.
Speaker: So these are the domestic elements, companies and corporate and businesses.
Speaker: Governments are looking for a plan B. And there's a significant,
Speaker: shift of supply chains towards India.
Speaker: I mean, imagine if smartphones start moving from being manufactured in China to India, each smartphone that you have in your hand is about 800 to 1000 parts.
Speaker: Once you move the smartphone manufacturing to India, you also have to move all those sub components slowly and steadily to India.
Speaker: So manufacturing is on the rise.
Speaker: But the big difference that India has made is in exports, which is really a differentiating factor.
Speaker: And
Speaker: The outlook for India is quite different, radically different from the rest of the world.
Speaker: Yes, there are commodity prices issues and oil is high, but to compensate for the high oil price, India's got food prices which are declining.
Speaker: In fact, in the recent aftermath of the Ukraine invasion, we've become a big agricultural exporter.
Speaker: We're exporting wheat to the biggest buyers, that's Egypt and Turkey.
Speaker: So new avenues are being found, the void left by China and Russia is being eagerly met by India.
Speaker: So the outlook is good.
Speaker: Excellent.
Speaker: Thank you, Praveen.
Speaker: I think that sums up very nicely.
Speaker: Thank you for listening today.
Speaker: This has been HSBC Global Viewpoint, Banking and Markets.
Speaker: For more information about anything you heard in this podcast,
Speaker: or to learn about HSBC's global services and offerings, please visit gpm.hsbc.com.
