Commodities key to finding fixed-income deals in emerging markets

Commodity exposure is a significant driver of fixed-income health in emerging markets, says Alberto Boquin, senior research analyst with the global fixed-income team at Brandywine Global Investment Management.

“Anyone who exports commodities has done well,” Boquin said on the Soundbites podcast. “Brazil and South Africa stand out. You can see that in their fiscal accounts; they’re collecting more tax revenues. And you can see it in the current account balances because they’re just exporting a ton more commodities.”

Countries that are net commodity importers, like Turkey and India, face bigger challenges from a fundamental standpoint. “There’s been discussion about whether we’re approaching a commodity super cycle in the last few years; the one thing that’s been missing is investment in commodities,” he said.

Even China, the epicentre of a commodities boom in the early 2000s, has struggled to attract investors to keep its exports flowing.

“Foreign direct investment hasn’t materialized,” he said. “You have a supply shortfall, where the world still needs a lot of commodities, and there’s not that many people providing them.”

Countries that have kept exports flowing have benefited, he said, and there are bargains to be found.

The other factor that has helped some emerging markets is their policies through Covid and their strategies coming out of the pandemic.

“You had central banks cut rates to historical lows. You had a lot of fiscal stimulus coming out. And with the bounceback that we had, people started winding that back. The ones that were quicker to wind that back are in a better position right now,” Boquin said. “In hindsight, we generally stimulated a little bit too much and were a little too slow to tighten.”

As a result, countries such as Brazil and Chile, which started raising rates mid- to late-last year, are now ahead of other developed markets, he said.

For careful buyers, there are some great deals to be found.

“In terms of valuations, it’s the most attractive investment opportunity I’ve seen in 10 years,” he said. “You just have to be able to pick your names, rather than make index bets.”

He said high-yield corporates in the single-B and below space will undergo intense scrutiny in the months to come.

“A lot of issues are simply not going to be able to refinance, given ongoing fundamentals, the fact that we’re looking at a recession over the next 12 to 18 months, and defaults are going to rise in that space,” he said.

“Better-quality corporates, especially the ones that have pricing power in this environment, are going to do better off. You have a lot of bonds trading in the 70 to 80 cents on the dollar, and so they’re finally attractive from a risk-reward perspective.”

Sovereign debt is similarly strained, he said, with some countries under severe duress.

“A lot of the stuff in the single-B space [and] triple-C stuff is looking pretty challenging,” he said. “Some countries got a lot of financing when there was an ample liquidity backdrop. Now the markets are reconsidering what to do with the likes of a Ghana or a Sri Lanka.”

He said currency dynamics could work in investors’ favour.

While developed economies have seen interest rates rise to 3% or 4%, a lot of emerging markets are looking at rates of 10% and higher.

“So, even if you think a currency is going to move against you, if you have a 10% cushion, it starts becoming attractive,” Boquin said.

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.