The low-yield environment in the developed world has also lowered Western investors’ return expectations from emerging market debt. As a consequence, projects requiring joint financing by the government and private investors now meet the latter’s return requirements, says Invesco’s Wim Vandenhoeck.
Vandenhoeck sees great opportunities in public-private partnerships (PPPs) in emerging economies, especially in the field of infrastructure. In PPPs, a government issues bonds, the proceeds of which are used for a pre-determined project.
Vandenhoeck is an experienced EMD investor who has been at the helm of the newly launched Invesco Emerging Markets Local Debt Fund since August 2019. He manages it together with Hemant Baijal. Both joined the asset manager from US-based Oppenheimer Funds in the same year.
‘We invested in such a PPP-bond for the first time three years ago, for the construction of a tunnel in Colombia›, says Vandenhoeck, who usually works from New York but is now temporarily working from his sister’s study in Leuven because of the Covid-crisis.
Until recently, PPPs were almost impossible to get off the ground in emerging markets because the financing costs for governments in these countries were simply too high. ‘Foreign investors were requiring double-digit, private equity-like returns for this. But with the hunt for yield that has resulted from ultra-loose monetary policy in the West, those same investors are now settling for something like 7%,’ says Vandenhoeck, who therefore expects a boom in such projects. Another recent example he mentions are the social bonds Chile issued last year in response to the mass protests against inequality in the country.
Infrastructure also leaves much to be desired in many emerging economies, and countries often rely on loans from China to build badly needed roads, railways and ports. PPPs are a welcome alternative for this.
ESG problem
PPP’s also offer investors an immediate opportunity to make an impact in the ESG field, notes Vandenhoeck. ‘The PPP in Colombia is basically a win-win-win situation. It gives the investor some 400 bps on top of the return on an ordinary government bond, it is good for the local population because it stimulates economic activity, and it is therefore often good for the ESG-profile of the investment too.’ For example, a tunnel where the only connection to the outside world used to be a winding mountain road can lift farmers out of poverty and save CO2 emissions.
So far, ESG has often been neglected by investors in emerging market debt, Vandenhoeck admits. After all, most governments in emerging markets have poor track records when it comes to governance, democracy and environmental policy. ‘But, and perhaps this is a silver lining of the pandemic, I have noticed a turnaround recently›, says Vandenhoeck. ‘There is increasing pressure on governments in emerging markets, including from Dutch pension funds. And nowadays you can also discuss ESG during meetings. A few years ago, that was unthinkable.’
Positive momentum
Nevertheless, for the time being the ESG reputation of most EMD local currency issuers leaves much to be desired. Vandenhoeck therefore focuses in his selection process on countries which show ‹positive momentum› in the ESG field. According to him, this is the case for Colombia, by far the largest position of his fund with a 14% allocation. ‘Colombia is a fairly stable democracy which, moreover, has shown the ability to consolidate its debts after the commodities crisis of 2014/15. So I am not losing any sleep over Colombia.’
Brazil and South Africa, two of the largest positions in the JPM GBI-EM Index (the benchmark of Vandenhoeck’s fund) are a different story. Both countries struggle with rapidly rising government debt, stubbornly low economic growth and a weak currency. ‘The jury is still out on these two countries,› says Vandenhoeck. That is why his main focus here is on valuations. ‹As a result of their economic problems, both of these countries have quite steep yield curves.› Vandenhoeck’s assessment results in a slight overweight to South Africa and a small underweight to Brazilian bonds.
Hungary
But probably countries with negative momentum greatly outnumber those with positive momentum. An example of the former category is Turkey. ‘We have not had any exposure to Turkey for at least three or four years. The country has recently been seeking a rapprochement with the West, but Erdogan is still in power. As long as that remains the case, few fundamental changes will take place there.’
Another black sheep is ‹Viktator› Viktor Orbán’s Hungary. ‘At the end of March, we sold our total position in Hungary when parliament there was completely sidelined. That such a thing can happen in Europe in the year 2020 is shocking›, said Vandenhoeck. ‘So I do not expect Hungary to return to our fund at any point.’
In this respect, it is striking that Vandenhoeck overweights Russia, where the parliament has not had a say for years. Following the poisoning of opposition leader Navalny, the country even seems to be on a path towards repressive dictatorship. But Russia is a bond investor paradise.
‘Fundamentally, Russia is probably the best country in the whole EMD spectrum›, says Vandenhoeck, referring to the country’s low public debt and trade surplus. After the outbreak of the coronavirus crisis in March, the Russian government chose to prioritise public finances. Whereas Western countries came up with generous support packages for businesses, Russia only supported large state companies. SMEs did not receive a single rouble from Putin. Bond investors were better able to appreciate this frugality than the Russian population. After a brief rise in March, the Russian 10-year interest rate has fallen sharply over the past year. At 5.88%, it is now below the February 2020 levels.