Fixed Income Boutique
Russia and OPEC failed to come to an agreement on production cuts to support the price of oil in response to the coronavirus. As a result, Russia decided to ramp up production, which Saudi Arabia reacted to by announcing an increase in its production, sending the price of oil into a tailspin.
Russia may have thought this an opportune time to hurt American shale oil producers, who will undoubtedly suffer from lower prices. However, fighting the shale producers is not an easy task. Basically, affected producers are likely to move into a “zombie state”, as pushing too far, into default, generally results in a take-over by more cost-efficient peers.
We are witnessing a geopolitical tussle between two countries with strong-willed leaders. Whether President Vladimir Putin and Crown Prince Mohammad bin Salman (MBS) decide to fight it out, or will pragmatism prevail, remains to be seen. Nevertheless, a prolonged conflict is not in the interests of either party, as a low oil price will stand in the way of the Russian government’s target of boosting economic growth to 3% and MBS has big plans for the Saudi economy, which would be in danger of being derailed if oil prices remain low. Therefore, we believe a solution is forthcoming, but it could take some months rather than days. For markets, obviously, the earlier this is solved, the better.
Although in the past few days we have seen a broken market, due to oversupply fears, it is important to note that this appears to be a short-term event. As our colleague in the Multi Asset boutique, Senior Portfolio Manager Michael Salden, wrote in his recent Market Update: “Regardless of current market moves, oil markets are set to shift into structural undersupply by 2023-2025 since major oil producers did not invest in new infrastructure projects and shale producers have been favoring dividends rather than capital expenditures to support new production facilities.”
In the Vontobel Fund - Emerging Markets Debt, we are underweight oil exporters compared to the benchmark, for example, we have an underweight in countries like Kazakhstan, Kuwait, and Bahrain. Oil exporters that we do hold an overweight in are in Angola, Congo, and Nigeria (small overweight). We also hold an overweight in Ukraine, which is an importer. Overall, our position in oil exporters, balanced for their net export versus GDP size, is underweight.
Mr. Putin’s decision to ramp up production resulted in spreads in Russia widening by around 75 basis points over the past weekend. However, we are underweight in Russia. Azerbaijan was also hard hit, with spreads widening by around 100 bps from Friday to Monday and by more than 205 bps since February 13 (the date at which they have been the lowest in years), but there we are also underweight. We are also underweight in Saudi Arabia and other Middle Eastern debt, which (just like Russian debt) was hammered with 10-year and 30-year yields spiking, for example.
The overall market reaction has been severe, comparable to the commodity price shock of 2014-2015. Central banks are showing a clear willingness to help, but they have limited firing power, because supply-chain breakups cannot be fixed with monetary policy, nor can central banks prevent the coronavirus from spreading. On the other hand, fiscal policy can at least contain side effects to some extent. As of now, the liquidity around oil affected sovereigns and issuers is poor, with little trading going on. As mentioned above, we would describe the credit market during the past few days as broken. It is also a market where you can do great deals by giving liquidity to panicking sellers, as in our view, the reaction is overdone and, thus, we are in the process of buying.
When looking past the panic and stress, we can see that Treasuries are an important point of support as 90% of the remuneration for emerging market debt investors is now coming from the spread, which is, for instance, currently around 445 bps for the J.P. Morgan EMBI Global Diversified (as of March 10). Once the dust settles, investors will realize that the carry has increased significantly and this will be a motivator to buy. We will continue to employ the strategy that has delivered returns to our investors over the long-term: buying with high conviction and taking advantage of market inefficiencies when we see opportunities arise.
Vontobel Fund - Emerging Markets Debt
USD I LU0926439729
|Index||J.P. Morgan EMBI Global Diversified|
|Time Period||15.05.2013 - 29.02.2020|
|Rolling 12-month net returns (in %)|
|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.