It has been a tricky start to the year for emerging markets, after a risk-on December. On the corporate side, the JPM CEMBI Broad Diversified Index is down around 150bps so far this year, driven in part by China, which accounts for roughly 5% of the index. At the same time, in terms of sovereign bonds, the JPM EMBI Broad Diversified index is down around 270bps, led by investment grade countries.

 

To date, January’s performance has been driven by systematic and idiosyncratic factors. We’re seeing a policy shift in the developed world, with rising interest rates, as well as higher energy prices and inflation. We also have several elections coming up this year in EM, which further adds to asset class volatility. On the FX side, it’s hard to predict US dollar moves, which will depend on whether the US Federal Reserve (Fed) tightens less or more than expected, as well as developments in China.


As a team, the question we ask ourselves is, what’s in the price, given how bearish the market is right now? From a risk-reward perspective, EMD is at the cheapest it’s been in the past five years. We believe the asset class provides a valuation cushion, and it’s extremely diversified, across around 100 countries.


In this environment we favour credit default swaps as hedges, as well as companies with natural hedges like exporters that can support cashflows, and we’re able to identify BB names with enough spreads and good fundamentals to potentially cushion against volatile rates. We see the current environment as a great opportunity for bonds in companies with improving cash flows, good stories and high yield, which should benefit when the market turns.