A global network of investment points

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Fixed income investors would do well to think globally rather than restrict themselves to their fiscal comfort zones, says Tracy Chen, head of structured credit at Brandywine Global Investment Management in Philadelphia. 

Chen finds there’s a world of opportunity for fixed-income investors especially as economies emerge from Covid lockdowns and governments look to stimulate growth. 

According to Chen, most investors tend to invest in domestic bonds rather than look further afield because they are more familiar with the issuers or more confident in their own economies. 

“What they fail to realize is that the market is a lot bigger than they think,” she said. 

For example, she said, a U.S. bias for fixed-income products unnecessarily handicaps investors. 

“If you limit your investment to U.S. markets, you are losing about 40% of the global fixed-income market,” she said, because the U.S. fixed-income market only accounts for 60% of the global market. 

She advocates holding a core of U.S. fixed-income investment, but allocating 30% to 60% to bonds from Europe, Asia, and South America. 

Chen uses a three-pronged approach to finding opportunities in the crowded international bond market: she identifies countries with good fundamentals, seeks a diversity of yield curves and manages currency risks. 

“You have three fronts of alpha generation there, she said. 

Among the fundamentals she examines are near-term growth drivers, and the amount of debt held at the household, corporate and sovereign levels. She also reviews countries’ monetary and fiscal policies, the independence level of their central banks, and where countries are in their economic cycles. 

“It’s all about cycles,” she said. “Some countries can do well in a particular year, whereas that country will do worse the next year. So, by rotating in and out of some countries you can gain a lot of alpha in your total return.” 

Egypt & China

She is particularly favourable toward Egypt, which she defines as a frontier country that is a “great investment in this very low interest rate and low-yield environment.” Among other accomplishments, Egypt has wrestled inflation down to 5% from over 30% a few years ago. 

“I think that’s great progress, and we expect it to remain in the mid-single digits going forward, she said. 

Egyptian treasury bills currently offer yields in the low teens an attractive rate made all the more impressive compared to emerging market countries, where real rates range from 1% to 3%. 

Chen said the Covid shock was very harsh for Egypt’s balance of payments due to restricted tourism inflows and falling remittances from oil workers. But robust foreign reserves have served as a buffer against economic calamity, and the state bank was nimble in counterbalancing dollar outflows during the pandemic’s peak. 

“As a result, the authorities have been able to maintain access to capital markets in a very challenging market, and their ability to keep rolling over their debts,” she said. “This investment has very good carry, as long as they can keep this fundamental going. 

Chen also likes China, which curates the second-largest bond market in the world. She said the Chinese government has effectively managed the second round of the Covid crisis, potentially avoiding a second stimulus spend and strengthening its current accounts. 

Furthermore, the country’s exports are booming as peers struggle with supply chain disruptions. 

She said Chinese government bonds offer among the highest real yield among emerging market countries. 

“Chinese government 10-year bonds are yielding 3.2%, compared to the U.S. 10-year bond which yields only 1%,” she said. “So you have a 220-basis-point pick up.” 

On the flip side, countries like Argentina and Turkey have had difficulty controlling debt because of their dependence on foreign investments, Chen said. The resulting economic weakness only requires more foreign money, leading to a vicious cycle. 

Chen cautioned against valuation traps, such as bonds issued by a known serial defaulter.  

“We have to look at where the true fundamental risk is,” she said. “What is the information that we don’t know that will present risk to us later on?” 

Looking at pricing risks and information risks is part of the necessary screening process that separates deals from disasters. 

“You have to identify the genes of each emerging market,” she said. Sometimes [bad] genes are there. You cant change much. 


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

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