By tarnishing the appeal of countries typically associated with predictability and stability, the UK's vote is making emerging-market risks more palatable for those seeking a refuge from negative yields
London, Moscow: Britain’s vote to quit the European Union (EU) has flipped perceptions of global political risk on their head.
Brazil’s new government and Russia’s isolation represent a buying opportunity for Europe’s biggest asset manager as political chaos across the continent erodes developed economies’ traditional haven status. Even before the Brexit vote, price swings for bonds in advanced nations had eclipsed those of less-developed peers, exposing investors to greater risk.
“You can certainly make the case that some emerging markets are now safer than parts of the developed world," said Sergei Strigo, head of emerging-market debt at Amundi Asset Management in London, the continent’s biggest investment firm at $1 trillion under management, which had positioned for a British vote to leave the EU.
Strigo is considering adding more Russian and Brazilian hard-currency bonds to his portfolio and is overweight on Argentina and Mexico. He’s not alone. While global markets tanked Friday on the referendum results, BNP Paribas Investment Partners loaded up on exposure to Russia, Colombia and South Africa through credit-default swaps.
Analysts at Societe Generale SA touted local-currency notes in Moscow on Monday for their “safe-haven glow," while stocks traded in Johannesburg attracted the most inflows last week since March 2009. Investors put $1.75 billion into US exchange-traded funds that invest in emerging-market debt and equities last week, the most in three months, data compiled by Bloomberg show.
Volatility in stock-trading exhibited starkly different reactions. Thirty-day volatility in US, European and UK markets spiked after the vote and remain above where they ended the first quarter.
The reaction from traders of stocks in Brazil, Russia, India and China, meanwhile, was fairly muted, with 30-day volatility levels barely moving, leaving them down or almost flat versus 31 March.
By tarnishing the appeal of countries typically associated with predictability and stability, the UK’s vote is making emerging-market risks more palatable for those seeking a refuge from negative yields. Brexit has sent the pound into free-fall and left investors scrambling to understand how the weakened EU will affect Europe’s economic and political future.
For all its political risk, buying UK government debt due in 10 years offered a yield of 0.98% as of 8:34 AM in London. In Russia, Brazil and South Africa, the same notes pay between 8.5% and 12%.
“It’s best to stay away from European assets due to the uncertainty, and it’s worth looking at developing markets, where Russia and the rouble look quite attractive," said Yury Tulinov, head of research at Rosbank PJSC in Moscow. “At a time when the European integration is breaking apart, a relatively isolated Russia looks like a safe haven for investors."
US and EU sanctions against Russia imposed two years ago have allowed it to disentangle itself from trade ties with Europe that are rocking developed markets. Political overhauls in Brazil and Argentina driven by former Wall Street bankers in government posts are winning back investors after years of recession and spendthrift policies that swelled budget deficits.
Irony of sanctions
Russian local currency OFZ bonds due in 2027 yields 8.51%, after dropping more than 30 basis points this month to the lowest in two years. In that time, EU and US sanctions over the Kremlin’s role in the Ukraine crisis closed foreign debt markets to Russia’s biggest state-controlled companies and forced Moscow to distance itself from Europe.
“Ironically, the sanctions have helped protect Russia," said Jan Dehn, head of research at Ashmore Group Plc, which manages $51 billion of emerging-market assets. “Russia has in effect been forced to not rely on European or US banks, so it is relatively insulated."
A Bloomberg index of developed-country bonds handed investors higher absolute annualised returns of 11% so far this versus 9% for emerging-market peers’ dollar-denominated debt. With volatility factored in, however, developing nations come out on top, with risk-adjusted returns of just under 1.6% versus 2.1%.
The UK referendum has thrown the nation into political upheaval: its prime minister, David Cameron, has resigned and speculation is growing that Scotland, where citizens voted overwhelmingly to stay in the EU, will seek a referendum on sovereignty. S&P Global Ratings removed the UK’s AAA grade on Monday, stripping the nation of its last remaining top rating among the three major companies.
While politicians wrangle over Brexit negotiations that could take two years, a climate of uncertainty may continue to hang over the region’s markets and prompt US and European central banks to keep stimulus intact for longer, another boon for the bond market.
Most countries in Latin America are going through a period of relative calm. In Argentina, president Mauricio Macri has spent his first months in office taking steps to remake the economy in a fashion more friendly to investors. Peruvian voters recently elected the presidential candidate most favoured by the country’s business executives. And Brazil seems closer to resolving a months-long political stand-off as acting president Michel Temer takes the reins while Dilma Rousseff awaits an impeachment trial that could end her mandate.
“I like countries far from the epicentre," said Bryan Carter, head of emerging markets (EM) fixed income in London at BNP Paribas Investment Partners. “With ultra low interest rates, EM has attractive valuations and is one of the only places to go for yield pickup." Bloomberg
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