Investment Adviser:

NETA Capital Croatia d.d.

(February 2014)


Emerging market (EM) currencies have suffered a bit over the last few months. How has this affected emerging markets and emerging market bonds?

Emerging markets saw significant cash outflows during the last few months due to changes in the US Federal Reserve’s monetary policy and fiscal challenges in this new environment. Consequently, most emerging market assets recorded moderate losses. JP Morgan GBI-EM Global Diversified Index fell 9% in 2013 due to an increase in US Treasury yields, as well as a widening of spreads due to a deterioration of fiscal fundamentals.


Are you concerned that EM currencies will continue to lose value for some time to come?

The volatility of emerging market currencies will most probably remain elevated in the forthcoming period as many countries have to undertake painful structural reforms to help facilitate faster economic growth. However, most of the bad news has already been built into market expectations and the worst period is behind us. Although possible, we don’t expect a dramatic devaluation of emerging market currencies in 2014. In addition, local currencies are an integral part of our strategy as they offer attractive yields and significant diversification benefits. Thus, we will maintain moderate exposure to local currencies in the near future.


The latter part of 2013 saw all markets affected by speculation over US Federal Reserve monetary stimulus tapering. Now this has happened, what effect has this had on EM bonds?

Following an improvement of macroeconomic conditions in United States, the Federal Reserve announced it was to taper its quantitative easing policy by USD 10 billion per month, to USD 75 billion. That decision has negatively impacted emerging market assets as they had been one of the prime beneficiaries of the Federal Reserve’s quantitative easing since its introduction.


Some reports suggest that while some investors have been pulling out of EMs and EM bonds because of concerns of an end to US stimulus, institutional investors have actually been putting money into this asset class for much of the year. Is this something you have seen and if so, where in particular has this happened?

The long–term outlook for EMs is bright due to favourable demographic trends and increasing investments. Emerging markets are drivers of global economic growth and their bonds, as well as other asset classes, offer attractive returns on a risk-adjusted basis. Thus, it is not surprising that long–term investors are exploiting such opportunities to buy at cheap valuation levels.


How did EM corporate debt perform in 2013 compared to sovereign debt and which EM regions have seen the best corporate debt performance?

Emerging market corporate bonds outperformed sovereign issues by 4.66% (the JPMorgan Corporate EMBI Broad Diversified Composite returned 0.6% while the JPMorgan Emerging Markets Bonds Index EMBI Global Diversified Composite lost 5.25% in 2013). It is important to mention that this is, to a large extent, a consequence of longer durations of sovereign bonds. African corporate bonds were the best performers last year, followed by issues from Middle East corporates.


Do investors usually ignore a country’s corporate debt if its sovereign debt is unattractive or risky and if so, are they making a fundamental mistake?

Sovereign debt ratings and yields play an important role in the valuation of corporate bond issues and thus, highly risky sovereign debt has a significant impact on corporate bonds. However, corporate bonds should be considered as a potential investment even if government bonds are seen as carrying an unfavourable risk if their return trade-off looks attractive.


Are there any countries in your investment universe where sovereign debt is doing particularly badly and corporate debt very well and vice-versa?

In 2013, Asian and Latin American corporate bonds performed best relative to comparable sovereign issues. The JPMorgan Corporate EMBI Broad Diversified Asia Index added 0.16% while the JPMorgan Emerging Markets Bond Index EMBI Global Diversified Asia lost 6.37%. In Latin America, the corporate bond index declined 2.66%, outperforming sovereign issues by as much as 5.04% in the year.


How do you see the EM bond market developing over the next three months?

It would be very difficult to predict market movements in the short-term, especially in periods of relatively high volatility. However, we expect emerging debt markets to stabilize in the short-term as there is no significant downside potential from current levels, and, if we are lucky enough to avoid any severe negative events, emerging market bonds could record moderate gains in 2014.


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