EM bonds coronavirus. Our positioning and outlook

When news of the coronavirus began to hit headlines in late January, markets were complacent regarding the impact. The initial assumption was that the economic impact would be temporary, as China seemed to be taking the necessary measures to contain the outbreak and cases outside China/Hubei seemed to be limited – equities continued to move higher, which indicated little to no concern on global growth. However, rates and commodities fell, rates on a combination of anticipated central bank rate cuts and a flight to safety; commodities on anticipated lower demand from China and the rest of the world.

As the coronavirus spread around the globe markets began worrying about the economic ramifications of a prolonged epidemic and asset prices reacted accordingly. The spread of Covid-19 to Europe and other parts of the world increases uncertainty on the future path of the virus, and how disruptive it will be for global growth. Therefore, we believe, the correction we see now is due to an increase in risk premia mainly associated with increased uncertainty on global supply chain disruption and therefore global growth.

Now, in China, the situation appears to be contained, but there is skepticism around the reliability of the data. Although, we do believe that in China the worst is now behind us. However, it is clear that the virus is now spreading across the world. The effect on economic activity is both a supply and a demand shock. Policymakers are taking action and are doing the best they can to contain the economic fallout, the IMF has pledged 50 billion US dollars and the World Bank 12 billion, for example. Central banks are also taking steps to support markets, but monetary policy is unlikely to be effective in the near term in helping ease affected supply chains. As people are fearful, this translates into Treasury yields sinking lower.

We expect volatility to continue going forward, we see it in rates and FX, which reflects the higher uncertainty and, therefore, a higher discount rate. As a result spreads have widened to reflect the heightened uncertainty. In addition to the coronavirus, the oil-price war between Saudi Arabia and Russia that kicked off over the weekend is adding to the overall sense of unease.

Our EM bonds positioning

Prior to the outbreak of Covid-19, we had been reducing risk after the strong rally at the end of last year and early this year as we felt that yields had become low. Remember, just a few weeks ago equities were touching new highs.

On the Sovereign side, last month, the Vontobel Fund – Emerging Market Debt underperformed its reference index. This was a result of the combination of our higher beta (particularly African names in our portfolio) and a slight underweight in rates as rates have collapsed.

The Vontobel Fund – Emerging Markets Corporate Bonds also underperformed. In addition to the market weakness due to the coronavirus, and our higher beta and short on rates stance, we are invested in an idiosyncratic story where the performance was weak in February. Overall, EM corporate bonds have been much more resilient than many developed corporate and high yield in particular. It’s part of investing that there are periods of panic selling and in these situations policymakers take action. With the coronavirus it’s a situation of companies adapting to the new reality as the virus itself is not that deadly for most of the global population.

In the two above mentioned funds (EM Debt and EM Corporate Bonds) we seldom have FX exposure, both being predominantly invested in hard currencies. However, we do note that local currencies have been resilient during the virus outbreak, suggesting that market positioning is light. Should there be any weakness in the US dollar, once the virus subsides, local currencies should perform well.

Outlook

Liquidity remains good, (in EM, of course, always dependent on specific issues). We are monitoring flows closely and have not seen big outflows, on the contrary, we have seen inflows. We will continue to do what we have always done, trying to find bonds that are cheap for the value they provide.

We will maintain higher cash levels than usual, so that we can benefit from the volatility and market dislocations. Given our view that the virus impact will be temporary, albeit hard, we do think spreads are now attractive. We are constructive on local currency, but see value in hard currency and corporate bonds in particular. The yields at sovereign level are now around 5%. With rates so low, we intend to increase the spread while taking into account the volatility. With sovereigns, when we feel the time is right, we are looking to go into higher duration or go a bit lower in credit quality. This is somewhat different to what the market is doing, however, this is consistent with our contrarian approach, which has continued to deliver long-term outperformance and returns to our investors.

 

Vontobel Fund - Emerging Markets Corporate Bond

 

FUND CHARACTERISTICS
Share Class	Vontobel Fund - Emerging Markets Corporate Bond USD I LU1305089796
Index	JPM CEMBI Broad Diversified
Currency	USD
Inception Date	13.11.2015
Time Period	13.11.2015 - 29.02.2020

Rolling 12-month net returns (in %)
	Fund	Index
28.02.2020 - 01.03.2019	7.9	10.6
28.02.2019 - 01.03.2018	5.0	3.1
28.02.2018 - 01.03.2017	12.0	4.2
28.02.2017 - 01.03.2016	25.5	11.8
28.02.2016 - 01.03.2015	n/a	n/a

Past performance is no guide to future performance.
Performance data does not take account of commission or costs charged when units are issued or redeemed. Source: Vontobel Asset Management.
 

Vontobel Fund - Emerging Markets Debt

 

FUND CHARACTERISTICS
Share Class	Vontobel Fund - Emerging Markets Debt USD I LU1305089796
Index	J.P. Morgan EMBI Global Diversified
Currency	USD
Inception Date	15.05.2013
Time Period	15.05.2013 - 29.02.2020

 

Rolling 12-month net returns (in %)
	Fund	Index
28.02.2020 - 01.03.2019	8.6	9.7
28.02.2019 - 01.03.2018	-0.1	3.1
28.02.2018 - 01.03.2017	10.6	4.4
28.02.2017 - 01.03.2016	18.9	12.1
28.02.2016 - 01.03.2015	-2.5	1.1

Past performance is no guide to future performance.
Performance data does not take account of commission or costs charged when units are issued or redeemed. Source: Vontobel Asset Management.