Emerging Markets Fixed Income
Established: Emerging markets fixed income is an asset class in its own right. Diverse: The size and scope of emerging markets delivers diversification Strong: Emerging market bonds have earned solid returns over the past several years. Alternative: Emerging market bonds have performed favourably against domestic bonds.
Opportunity beckons Even though emerging markets fixed income is not a new asset class, it is new to most investors in North America. This could be about to change for three important reasons.
1. Attractive yields
Five-year government bond yields (in local currency)
Interest rates are at or near historic lows in many developed economies, but emerging markets have maintained higher Canada 1.65%
rates due to relatively strong domestic economies and an
Poland 5.04%
Russia 7.54%
US 0.99%
emerging market risk premium. These higher rates are an
Turkey 8.32%
Mexico 4.99%
attractive opportunity for yield-hungry fixed-income investors
Venezuela 13.27%
as part of an overall diversified portfolio.
South Korea 3.64%
Indonesia 6.03%
South Africa 6.53%
Chile 5.19%
Source: Bloomberg; as at August 29, 2011
Cumulative Returns 550 500 450
2. Solid historic performance
400
Emerging markets debt has significantly outperformed
350 300
traditional equities and fixed income over the long-term.
250 200
Improving credit quality in emerging markets should, over
150
time, drive down credit spreads for emerging market bonds.
100 50 0 -50 1996
1997
1998
1999
2000
JP M E M B I G lobal
2001
2002
JP M E LM I+
2003
2004 JP M G B I
2005
2006
2007
M S CI E M E quity
2008
2009
2010
2011
M S CI W orld E quity
JPM EMBI GLOBAL = JP Morgan Emerging Markets Bond Index Global, JPM ELMI+ = JP Morgan Emerging Local Markets Index, JPM GBI = JP Morgan Global Bond Index, MSCI EM Equity = MSCI Emerging Markets Equity Index MSCI World Equity = MSCI World Equity Index
Emerging Market Bonds New Issuance, USD billion 250
3. Surging growth in new issues
200
The emerging markets bond universe now represents
150
approximately 14% of the global bond market. It’s now bigger than the entire developed-country high-yield bond market.
100
Source: JP Morgan January 2011
1
2010
2009
2008
2007
2006
Corporates & Quasi-Sov
2011E
Sovereigns
2005
2004
2003
2002
2001
0
market economies continue to post impressive growth.
2000
second-highest year of new issuance on record as emerging
1999
50
After an exceptional 2010, the year 2011 is set to be the
Emerging market bonds — diversity and opportunity Emerging markets are those countries undergoing rapid
According to the International Monetary Fund, the emerging
economic growth and industrialization. As part of a broader
world’s share of global gross domestic product (GDP) is
portfolio, emerging market bonds have the potential to enhance
expected to increase from 34% in 2010 to 41% in 2016.
returns and provide additional diversification for investors.
Emerging market bonds have grown into an important asset
These markets are as different from each other as the rich
class over the last decade as legal, regulatory and economic
cultures they each offer the world. Examples of emerging
climates in many emerging market countries have improved. The
markets include Brazil, Russia, and China — as well as other
emerging market bond universe has also expanded and become
Southeast Asian countries, Eastern Europe and parts of Latin
more diverse.
America and Africa.
1990
Market growth begins to outpace the legal and economic infrastructure of emerging countries
2007
Global financial crisis begins
1997 – 1998
2000 Asian financial crisis Mexico raised to • Currency depreciated investment grade • Growth declined • Requested emergency 2001 financial support from IMF Argentine default
Late 1970s
Global economic difficulties lead to defaults • Skyrocketing oil prices • Double digit inflation
1975
1980
1985
1995
2000
European sovereign debt crisis - bailouts of Greece, Portugal & Ireland
2005
2010 2011
1994
1970
Multinational banks in the US and Europe actively lend to developing markets
1990
2010
1980s
Mexican devaluation
Global debt and equity markets grow • Berlin Wall comes down • Eastern Europe and former Soviet Union participate in global world markets
2008
2003
US debt downgraded to AA
• Brazil raised to investment grade • Ecuador default
• Local debt sovereign issuance surpasses hard currency issuance • Russia raised to investment grade
1998
• Russian default • Long Term Capital Management crisis
2
2015
Different choices for different investment needs Investors have a wide range of emerging market fixed income opportunities to choose from — from powerhouses in regions such as Latin America to smaller players in Africa. Today there are 42 countries in the J.P. Morgan Emerging Markets Bond Index (Global), up from fewer than 15 in the late 1990s. As at September 2011, regional exposure to the Index was Latin America (44.7%), Europe (30.0%), Asia (17.8%), Middle East (3.7%) and Africa (3.7%). Investing in emerging market bonds can also help diversify an investor’s currency exposure. Emerging market bonds are denominated in either local emerging market currencies or in developed market currencies, such as US dollars, euros or yen. About US$1.3 trillion worth of emerging markets debt is denominated in developed market currencies, compared to the approximately US$9.6 trillion worth of emerging markets debt which is denominated in local emerging market currencies (BIS Quarterly Review, September 2011). Emerging market bonds can be sovereign debt issued by countries or corporate debt issued by companies. Since 2003, new corporate issuance has exceeded sovereign issuance in emerging market debt. This growth reflects the expansion and strong competitive position of many emerging markets companies.
3
High economic growth rates bode well for the future As many developed economies wrestle with sluggish growth,
Rapid expansion in emerging markets should, over time,
emerging economies continue to be the main drivers of global
allow them to command even greater attention in the global
growth. In 2010, more than two-thirds of global growth was
investment universe. In fact, emerging markets such as China,
driven by emerging market countries. These countries also
Brazil, Russia and India are already some of the world’s most
account for a rising share of world trade.
important and influential countries.
While developed economies struggled, two of the most
Of course, with every opportunity comes risk. But if emerging
populous countries in the world, China and India, forged ahead
market bonds are properly integrated into a diversified portfolio
with substantial GDP growth of 10.3% and 10.4%, respectively,
and held as a long-term investment, they can be suitable for a
in 2010.
wide range of investors.
Real GDP Growth
2009
2010
2011*
2012*
2016*
Brazil
-0.6%
7.5%
3.8%
3.6%
4.2%
China
9.2%
10.3%
9.5%
9.0%
9.5%
India
6.8%
10.4%
7.8%
7.5%
8.1%
Russia
-7.8%
4.0%
4.3%
4.1%
3.8%
Emerging and Developing Economies
2.8%
7.3%
6.4%
6.1%
6.7%
Advanced Economies
-3.7%
3.1%
1.6%
1.9%
2.7%
World
-0.7%
5.1%
4.0%
4.0%
4.9%
Source: IMF September 2011 * Forecast
4
Improving credit ratings can mean better performance The higher credit ratings of many developing countries are evidence of their improving economic fundamentals. At the end of December 2010, 57% of the market value of the J.P. Morgan Emerging Markets Bond Index was investment-grade debt, up from 30% in 2002 and just 5% in the late 1990s. We expect emerging market fundamentals to keep improving, which should translate into further credit rating upgrades and increased opportunities over time. There are many reasons for improved credit ratings in emerging markets. Fundamentally, the improvements are based on better legal systems, stricter government regulations and sound fiscal and monetary policies. Companies are also becoming more shareholder-friendly. In fact, many emerging market companies have evolved into competitive, well-run global players. Compared with a generation ago, they are better managed, with stronger balance sheets and an increasing ability to generate cash. Country
Sovereign Debt Rating
China Taiwan Chile Czech Republic Israel Malaysia Poland South Africa Thailand Mexico Russia Brazil Colombia Hungary India Indonesia Egypt Jordan Philippines Turkey Vietnam
AA-AAA+ A A AABBB+ BBB+ BBB BBB BBBBBBBBBBBBBB+ BB BB BB BBBB-
Canada Germany Spain US Italy Portugal Greece
AAA AAA AA AA A+ BBBCCC
Source: Standard & Poors, August 2011
5
Investor-friendly fiscal and monetary policies Gone are the days when emerging markets were synonymous
With reserves rising above US$3.2 trillion, China has the lion’s
with lax government policies and runaway spending. In sharp
share — accounting for around 49% of the world’s reserves.
contrast to many developed economies that have allowed
Brazil, Russia, and China are now net creditors, as their foreign
their debts to skyrocket, many emerging market governments
exchange reserves exceed their total foreign debt.
have turned away from the inflationary monetary policies and
Inflation
irresponsible fiscal actions that had discouraged investors in the
40.0
past. And unlike during previous booms, they have resisted the temptation to let spending rise unsustainably.
35.0
Efforts to tame inflation have also instilled more confidence
25.0
among investors. Although inflationary pressures are on the
20.0
30.0
15.0
rise, the average annual inflation rate among emerging market
10.0
countries in 2010 was moderate at around 5%, down from
5.0
between 15% and 25% in the late 1990s, according to the
0.0
International Monetary Fund.
-5.0 2007
Rising foreign exchange reserves are another important plus
Brazil
for investors, because they reduce the probability of default on foreign debt payments in the event of a crisis. The rapid increase Canada and Australia, many emerging market countries have benefited from these rising commodity prices because they have significant natural resources. This has allowed these countries to build significant foreign exchange reserves. Emerging market countries now hold over two-thirds of the world’s foreign exchange reserves. FX reserves (US$ billion)
% of Global FX Reserves
Brazil
288
4.4%
China
3,200
49.0%
Russia Emerging Markets
479
7.3%
4,357
66.4%
China
Source: IMF, September 2011
of commodity prices has also helped emerging markets. Like
Country/Region
2008
Sources: IMF, People’s Bank of China, August 2011
6
2009
2010
2011E
India
Russia
Canada
2012E US
The future looks bright The torrid pace of economic growth in emerging markets has seen them challenge the traditional economic dominance of developed markets. Their spectacular growth is being driven by many factors — in particular domestic demand, strong demographics, low debt and high savings rates.
Domestic demand: self-sufficiency spurs growth Significantly, recent growth has been driven by domestic rather than export demand, reducing emerging markets’ reliance on their developed market trading partners. Although emerging markets’ export-oriented economies were affected by the abrupt global downturn, the outlook for these countries improved markedly during 2009. In 2010, developments pointed to a strengthening of domestic demand and exports to other emerging market countries, as these emerging economies are now less dependent on the developed world for growth than they were a few years ago. Strong demand from within their own economies, together with trade with other growing emerging markets, makes these economies much more self-sufficient. Across the region, revenues from exports to other emerging markets have now overtaken exports to the developed nations, and domestic demand in many emerging countries is also growing quickly.
7
Demographics: young, well-educated and a growing middle class Longer-term growth is underpinned by a youthful, increasingly well-educated workforce. Emerging markets have favourable demographics: According to the CIA World Factbook, the median age in Emerging Market countries was 30.6 years in 2010, compared to a median age of 40.5 years in the G10 countries. These growing populations are fuelling consumer demand. The growth of domestic demand also reflects the rise of middleclass consumers in emerging markets. The development of financial systems to serve an increasingly wealthy population is just one example of the growing importance of the middle class. In China, hundreds of millions of people will enter the middle class in the coming decades. China’s middle class is already as big as the entire population of the United States. Today, over half of Brazil’s 192 million people are considered middle class. Emerging countries are also becoming increasingly urbanized. This is also driving infrastructure investment and development, which in turn is leading to new bond issuance.
Low debt and high savings: a virtuous circle The positive outlook for emerging economies is further underpinned by macroeconomic stability and a combination of low debt and high domestic savings rates. The debt levels in these economies are generally modest, and some emerging countries are net creditors. According to the World Bank, the total external debt of emerging market countries averaged 25% of GDP in 2010. In the G7 economies, sovereign debt burdens are now at about 100% of GDP. There is actually room in emerging markets for household debt to rise further, supporting future growth in consumption. Even in the event of renewed global weakness, many of these countries are in a strong position to use government spending and interest rate cuts to support economic growth.
8
HSBC’s Global Emerging Market Fixed Income Capabilities Living and working in emerging markets — HSBC leverages global knowledge and local insight At HSBC, we differentiate ourselves through our ability to combine global resources with local insight. We uncover exciting investment opportunities from within emerging markets. HSBC has a long history of emerging markets expertise, tracing its roots back to the foundation of the Hongkong and Shanghai Banking Corporation in 1865. Strategy
AUM USD (Millions)*
Benchmark
Inception Date
Emerging Market Bonds Core - Hard Currency
6,810.0
J.P. Morgan Emerging Market Bond Index Global (JPM EMBI Global)**
October 1998
Key Points
Predominantly invested in USD denominated sovereign and quasi-sovereign debt
Diversification in corporate and local currency debt Typically longer duration Emerging Market Bonds Local Debt
1,120.3
50% J.P. Morgan Government Bond Index - Emerging Markets Global Diversified (JPM GBI-EM GD)** 50% J.P. Morgan Emerging Local Markets Index Plus (JPM ELMI+)**
August 2007
Invested across local currency denominated debt and emerging market currencies
Typically medium duration
*As at July 31, 2011; ** It is not possible to invest directly in an unmanaged index.
Investment Management The portfolio management team is 100% dedicated to emerging markets fixed income, and employs a focused, disciplined, yet flexible investment process designed to exploit rapidly developing opportunities in emerging markets and to maximize risk-adjusted returns through diversified strategies. The team uses a combination of top-down — broad economic trends — and bottom-up — company specific — approaches to identify investment themes, select strategies, construct portfolios and manage risk. The team also prioritizes broad diversification of assets and strategies as well as high liquidity of holdings.
Analysis
Implementation
Assessment of Global Market Conditions
Investment Meeting
Country Analysis
Risk/Return Targeting
Top-Down Global Macro Themes
Bottom-Up Fundamental Research
Cross Market Analysis
Portfolio Creation
Security Specific Analysis
Execution
Monitoring & Risk Management
Risk Analysis
9
The commentary contained in this document is issued by HSBC Global Asset Management (Canada) Limited and is based on sources believed to be reliable. However, we have not independently verified such information and make no guarantee, representation or warranty and accept no responsibility or liability as to its accuracy or completeness. Opinions expressed in the document are subject to change without notice and this information is not intended to provide professional advice and should not be relied upon in that regard. You are advised to obtain appropriate professional advice where necessary and should consult your investment representative before considering a specific transaction. This document is not an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. We, our affiliates and our officers, directors and employees may hold a position in any securities mentioned in this document (or in any related investment) and may from time to time add to or sell any such securities or investment. As well, we and our affiliates may act as market maker or have assumed an underwriting commitment in the securities of companies discussed in this document (or in related investments), may sell them to or buy them from customers on a principal basis and may also perform or seek to perform investment banking or underwriting services for or relating to those companies. HSBC Global Asset Management (Canada) Limited is a subsidiary of HSBC Bank Canada and provides services in all provinces of Canada except Prince Edward Island. CA#M1111335 (11/11)