Transcript: Finding alpha in global fixed income
- January 26, 2021 January 26, 2021
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Welcome to Soundbites – weekly insights on market trends and investment strategies, brought to you by Investment Executive, and powered by Canada Life.
For today’s soundbites, we spoke with Tracy Chen, portfolio manager and head of structured credit at Brandywine Global Investment Management. We talked about the fixed income environment, and we started by asking why global diversity is so valuable.
Tracy Chen (TC): Global bonds offer a greater opportunity set, and allow investors to diversify their investments. They have more factors from which we can draw alpha. There are many developing countries that are actually liberalizing their markets. They welcome foreign investors, and they are growing very fast. Their share of global GDP and global fixed income is constantly increasing. So, as an investor, if you limit your investment to U.S. markets, you are losing about 40% of the global fixed income market because U.S. fixed income only accounts for 60%.
About multiple streams of alpha.
TC: There are advantages of investing in global bond markets. You can invest in multiple yield curves. Also, by rotating in and out of some countries you can gain a lot of alpha. And if you actively manage the currency, you can have another source of alpha. By choosing the right country, the right duration in different yield curves, and you manage the currency, you have three fronts of alpha generation there.
What she sees in emerging markets.
TC: In terms of emerging markets, there are a lot countries to consider. So, when we look at a country, we look at what stage is its economic cycle in, because it’s all about cycles. And then we look at the growth drivers. Is that country in growth recovery or late stage of their credit cycle. And what’s the leverage in various sectors: household sector, corporate sector, and government sector. And also, what’s the monetary and fiscal policies. Is the central bank tightening? Is the central bank dependent or independent? What is the current ratio for the country’s balance of payments? Can they sustain their borrowing? Can they pay back their foreign loans? Those are extremely critical questions for EM [emerging market] countries.
Why she’s keen on Egypt.
TC: When we analyze Egypt, we notice several brightening prospects. Inflation has gone from 30% a few years ago to the current of 5%. It’s a great progress, and we expect it to remain in the mid-single digits going forward. The T-bills rates are in the low teens. They have very attractive real rates. The Covid shock was very harsh for Egypt’s balance of payment. However, the government has built up a robust foreign reserve buffer and they were very nimble in counterbalancing dollar outflows during the peak of the pandemic. So, as a result, the authorities have been able to maintain access to capital markets.
Any other regional opportunities?
TC: Yeah, we also like China. It has the second largest economy in the world, and it has the second largest bond market. They allow their currency to appreciate in order to attract foreign investors. And the government has a lot of wherewithal to use when they are in economic downturn. This time around, during the Covid crisis, they contained the virus very effectively and they don’t need to use a lot of massive stimulus. So, the fiscal deficit and the current accounts are actually improving. The current account went from almost 0% at the beginning of the year to 2% positive. Their export is actually booming. They have a stronger currency and at the same time you get good carry. So, I think it is a great opportunity for fixed income investors.
And, finally, what the big risks are.
TC: The critical thing about investment is to look at pricing risk and information risk. We have to identify whether things are really cheap or they are just a valuation trap. And then the fundamental risk. What is the information that we don’t know that will present risk to us later on? This is a kind of screening process. When investing in emerging markets or frontier markets, you have to identify the genes of each emerging market. Sometimes the genes are there. You can’t change much.
Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life.
Our thanks again to Tracy Chen, portfolio manager and head of structured credit at Brandywine Global Investment Management.
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