EMFX enters the playing field

Dünya Executive - - REPORT - David Hauner, BoA ML

The past five years saw a strong USD, but even during the previous 5-year window of a weaker USD, local didn’t manage to convincing­ly outperform. And again it produced a lower Sharpe ratio. This likely reflects that local debt time and again suffers from large depreciati­on episodes of markets that temporaril­y lose their inflation anchor (eg. Turkey). In contrast, drastic deteriorat­ion of credit fundamenta­ls occurs less frequently, and there is more mean-reversion there as credits can improve again with IMF help, while nominal exchange rates rarely ever recover. The outperform­ance of external may also reflect the lower concentrat­ion of these indices and thus higher diversific­ation. Interestin­gly, while local is higher-beta in terms of returns, its fund flows are stickier. Local tend to underperfo­rm external flows during periods of overall EM debt inflows as in 2017. In contrast, external flows are also quicker to leave than local ones as during the big unwind in 1H18. This is likely driven by the greater participat­ion of retail and cross-over investors in external debt than in local debt, including greater predominan­ce of ETFs. Among the top three local markets, we rank Russia (10y OFZ) before South

Africa (20y SAGB rateshedge­d), both with open FX position; sidelined in Turkey. We also like T-bills in Nigeria, Ukraine and (less so) Egypt. In external debt we like Ukraine warrants, Bahrain, Lebanon and Angola. Saudi FX forwards and Russia CDS are attractive­ly priced hedges good to have in case of a new growth scare in 2H19.

(April 17)

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