An $80 Billion Debt Manager Finds Gems in Egypt and Ukraine
(Bloomberg) -- 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.
“We see 3.25 percent being a natural halting point primarily also because other markets like equity markets have become much more volatile,” he said.
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 4.86 percent Wednesday, while the 12-year securities had a 5.77 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:
- 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
- The company waited until there was “more clear-cut political change” in the country. It reversed estimates on some of the negative fundamental dynamics that were hurting the economy, including the current account.
- “We became much more positive that the inflation rate was peaking, but we’re worried on the currency”
- MSIM’s favorite in Asia is Indonesian sovereign bonds; they have reasonably high yields, the central bank is committed to currency stability and there’s an attractive economic backdrop, as credit upgrades show
“If you look at the universe of EM as a whole, stronger economic growth usually comes with stronger commodity prices, which lead to a better balance of payments, stronger currencies, lower inflation, lower interest rates and easier central bank policies,” Kushma said. “There’s no reason to expect it to do badly. But it’s coming under more duress from higher real interest rates in the U.S.”
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