Not all emerging-market debt is losing its allure as U.S. Treasury yields rise. At least not for Morgan Stanley Investment Management’s Michael Kushma.
Far from taking a more skeptical view of the asset class, Kushma, who helps oversee $80 billion in debt, says the trick is to seek securities in places where there’s relatively low interest-rate risk. It’s a strategy that leads him to talk enthusiastically of countries that many of his peers might say are too perilous to consider. Egypt and Ukraine for example.
“Real interest rates in the U.S. are rising, undermining a bit the real interest-rate premium that emerging markets have over the U.S.,” Kushma, the firm’s chief investment officer for global fixed income, said in an interview in Singapore. “The gap is closing a bit but it’s not like the gap’s gone away. The gap is still meaningful, so we still think emerging markets will do fine.”
While reducing exposure to government bonds and taking on more credit risk as synchronized global growth and expectations for tighter monetary policy drive up yields, the firm’s maintaining its positions in both local- and foreign-currency Egyptian bonds as well as Ukraine’s dollar debt. For sure, the strategy has its perils, but the country’s domestic stories dominate any external factors, according to Kushma.
U.S. 10-year yields breached 3 percent for the first time since 2014 on Tuesday, reducing the relative allure of higher-risk emerging-market debt. The median of 56 analyst forecasts compiled by Bloomberg is for 10-year yields to end the year at 3.15 percent. Kushma says they’ll climb to 3.25 percent within 2018.
Both Egypt and Ukraine, which have secured loans under International Monetary Fund programs, offer relatively higher yields that make them attractive investments, Kushma said. Egypt raised 2 billion euros ($2.4 billion) in eight- and 12-year bonds in its first ever euro-denominated debt sale this month. The eight-year notes yielded 4.83 percent Tuesday, while the 12-year securities had a 5.74 percent yield. Ukraine may tap international markets several times this year to raise $2 billion.
For Egypt, “the yield you’re getting on that country relative to the yield in other countries is attractive and we think they’ll do enough,” Kushma said. “Things don’t have to improve, just not get worse.”
Here are some of Kushma’s other recommendations and forecasts:
Brazil:
Kushma likes Brazilian bonds because inflation’s low; real rates aren’t coming down on the back of falling inflation and nominal yields aren’t falling fast enough. On the other hand, there are worries about the country’s currency and politics, so it’s preferable to buy the debt and hedge the currency risks