Goldman Sachs Dodges High-Yield Trap in Emerging Markets

(Bloomberg) -- For Goldman Sachs Group Inc.’s investing arm, there’s junk -- and then there’s junk.

The money manager is targeting higher-rated junk notes to boost emerging-market returns. Hard-currency bonds in the BB category, just below investment grade, are the sweet spot and should continue to outperform, according to Angus Bell, a London-based portfolio manager for Goldman Sachs Asset Management’s emerging-market debt team, which oversees about $45 billion.

So far this year, the best quality high-yield securities have returned 8.5 percent, versus a loss of 3.7 percent for debt in the C grades, according to data from JPMorgan Chase & Co.

“We try to avoid the trap of simply choosing the highest-yielding countries,” he said.

Emerging-market dollar bonds have outperformed the developed-market average this year as bullish global sentiment favored some risk taking. But the lowest quality securities have underperformed as nations such as Venezuela, Bolivia and Mozambique suffered from a mix of political tension, declining oil prices and missed debt payments.

The risk premium on developing-nation sovereign bonds climbed to 340 basis points as of 11:43 a.m. in New York on Friday, according to JPMorgan Chase & Co. indexes.

Here’s what else Bell had to say about emerging-market debt:

What emerging-market risks keep you up at night?

• Tighter financial conditions globally will have a cascading effect on emerging markets in many ways. It could change the demand picture.
• Still, there’s less risk of another so-called Taper Tantrum like we saw in 2013. That resulted from a confluence of factors including global commodity prices nearing their peak and a terms of trade shock caused by burgeoning current-account deficits. It wasn’t isolated around Fed commentary on tighter monetary policy.

Will the 19-month rally in emerging-market assets continue?

• Returns this year have been driven by mild to moderate spread compression and movements in the Treasury curve.
• Emerging-market returns in the first half of 2017 were solid and the base case is that “relatively solid returns” can continue for the rest of this year. Goldman Sachs Asset Management continues to favor locally-denominated debt over dollar bonds.
• Bell sees better value in Latin America on improving fundamentals, whereas the Middle East has seen some relatively tight spreads that don’t appropriately compensate for risks.

Is the emerging-market trade getting overcrowded?

• Flows that have entered the asset class have been more concentrated in hard-currency products, but that followed a multi-year period of declines. That suggests the potential for crowding is higher for hard currency and less so in local.

What are your top local currency emerging-market bets?

• The firm’s largest active overweight views are in Mexico, Russia and South Africa.
• Czech Republic, Turkey and Malaysia rank as the largest active underweights.
• The $2 billion Goldman Sachs Emerging Markets Debt Local Portfolio, which has topped 98 percent of peers this year, according to data compiled by Bloomberg, has benefited from longs in Central European currencies, the Mexican peso and active positioning in local rates within Argentina, Peru, Poland and Russia.

Are emerging markets the trade of a decade?

• From a strategic perspective, emerging markets will continue to offer traders yield. It’s broad and diverse within. That provides an opportunity for more highly-skilled managers to perform and deliver alpha.

--With assistance from Carlos Torres

To contact the reporter on this story: Ben Bartenstein in Lima at bbartenstei3@bloomberg.net.

To contact the editors responsible for this story: Rita Nazareth at rnazareth@bloomberg.net, Brendan Walsh