Fixed income specialist Brandywine Global has highlighted emerging markets (EM) as the sweet spot – or the least sour spot – for bond investors.
In a presentation to NZ investors last week, Brandywine Global portfolio manager, Jack MacIntyre, said for emerging markets bonds to outperform “things don’t have to get better, just less bad”.
However, he said the Brandywine Global thesis hangs on four key points, all of which probably have to play out to support EM bond returns.
World trade issues, in particular, would dominate the prospects for EM fixed income with the current round of US-China tariff talks likely to set baseline expectations.
The outcome of the high-stakes US-China trade talks would, of course, be critical for the world economy but MacIntrye said the ultimate political end-game was to use the threat of “high tariffs to get low tariffs”.
Brandywine Global is betting the superpower trade talks would be resolved without a crisis.
“Both the US and China are motivated to make progress on trade,” he said.
China and US economic conditions form two of the remaining three corners of the Brandywine Global investment case for EM fixed income.
MacIntrye said the firm’s analysis suggests the US economy would ease relative to the rest of the world with a number of key indicators pointing to a slowdown but not a recession.
The US central bank was likely to hold rates, he said, but could de facto tighten monetary conditions via its balance sheet reduction program. Last week the US Federal Reserve said it would proceed with caution while unwinding the massive bond holdings built up in the wake of the global financial crisis under the so-called ‘quantitative easing’ (QE) program.
Over the last couple of years the Fed has reversed QE to quantitative tightening (QT), slowly reducing its book of Treasury and mortgage-backed securities.
Fed vice chair, Randal Quarles, said last week: “If ever it appears that our plans for the balance sheet are running counter to the achievement of our dual-mandate objectives, we would quickly reassess our approach to the balance sheet.”
Regardless, MacIntyre said a relative US economic slowdown should also take the heat out of the dollar, with Brandywine Global positioned for a weakening greenback.
China, meanwhile, was poised to arrest a growth slowdown that has loomed as a big worry for global investors over the last couple of years. He said Chinese authorities were already moving to an accommodative stance with monetary and fiscal easing underway.
The Chinese economy, too, was structurally different than even a decade ago with a marked shift away from reliance on manufacturing to a service-based market. Upbeat Chinese consumers also support a strong domestic economy.
While the global factors appear to be in place, EM bond market valuations also fit with the Brandywine Global thesis, MacIntyre said. There was a “wide level of dispersion” of real yields between EM and developed market bonds, which he said represented a “mispricing of inflation expectations, not a pricing of credit risk”.
Brandywine Global operates under the umbrella of fund marketing firm, Legg Mason. In NZ the Brandywine Global Opportunities Fund – which invests across bonds, currencies and fixed income derivatives in an ‘unconstrained’ style – has attracted over $800 million, including $250 million in a recently-launched portfolio investment entity (PIE) vehicle, mainly from institutional clients.
While the Brandywine Global fund had a rough run over 2018 – down 1.4 per cent – over the five years to December 31 it was the top-performer in the ‘short duration and other’ global bond category, according to the latest Melville Jessup Weaver investment survey.
Colin Taylor, Legg Mason Australasia head of sales, said there was growing interest from the NZ retail market in the Brandywine Global PIE as investors reevaluated their fixed income exposures.
“As I engage with local investors I can see they have been underweight bonds for some time,” Taylor said. “But with an expected slowdown in global growth, NZ investors are likely to shift some capital away from equity to international fixed income.”