Timing is good for emerging market sovereign bonds

Sovereign bonds in emerging economies like South Africa and Mexico could outperform those of developed economies over the next year, says Anujeet Sareen, a portfolio manager with Brandywine Global Investment Management.

Sareen, portfolio manager for Brandywine’s global fixed income and related strategies, said certain developing nations could lead the bond market as world economies return to normal following pandemic-induced strains.

“Where are the places to invest? I am still going to return to emerging markets, local emerging markets bonds, particularly in countries like South Africa and Mexico,” he said.

“We want to invest in countries that have higher real interest rates than others,” he said. “The less you’re being compensated for inflation risk, the less attractive it is to own those bond markets.”

South Africa’s annual inflation rate has fallen steadily since 2016 and was 4.6% for the month of July. Meanwhile, Sareen said, 30-year bonds are offering 10.5% or 11% return.

“That is a lot of excess yield above the run-rate of inflation,” he said. “Investors are being well compensated to own those bonds.”

While he said that the country has “some significant challenges” with regard to long-term fiscal debt, president Cyril Ramaphosa is taking steps to address those concerns.

“So, that’s a bond market that we think is really worth considering at this stage,” he said.

Similarly, Mexico has a fiscally conservative leader in Andrés Manuel López Obrador, who is guiding the economy well and creating opportunities for investors, Sareen said.

The window for developed-economy sovereign bonds, on the other hand, has closed.

“The bond markets that we are avoiding are the higher-quality government bond markets that you are mostly looking to hold during times of economic stress. We’re not in that kind of a period anymore,” Sareen said. “The opportunities that presented themselves last year have diminished.”

He said negative nominal and real interest rates in some developed markets have steered investors in different directions.

Those bonds are “just fundamentally unattractive assets because your starting point — the yield — is already telling you you’re going to lose money over time,” he said.

The prognosis for many developed economy sovereign bonds is uncertain due to concerns that inflation could be more protracted than optimists are suggesting. He said those who believe inflation is transitory are downplaying the effects of massive government stimulus spending in the past 18 months.

“We printed a lot of money this past year and a half. Because central banks pursued quantitative easing policies back in 2009–2011 that did not lead to inflation, there is a sense today that it’s not going to do so again. It just doesn’t create inflation. We would disagree,” he said. “Don’t think that monetarism is dead. It is still alive, and I think we’re going to get a taste of that over the coming year.”

Sareen said the main reason we didn’t see runaway inflation after the Great Recession was because banks were crippled with their own accounting problems and stopped lending money. That is not the case this time around.

“There is scope, we would argue, for a bit higher inflation,” he said. “We’re not talking about runaway inflation but maybe something a little less sanguine than what central banks expect.”

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