Aviva Investors Emerging Markets Bond strategy: Lessons learned and looking ahead

In this article, we celebrate the 20-year anniversary of the Aviva Investors Emerging Markets Bond strategy, which was recently recognised for International DFM Fund/Product of the Year at the 2023 International Investment Awards¹. 

The strategy is managed by a longstanding, experienced portfolio management team led by Aaron Grehan who has been co-managing the strategy since 2010 and Mike McGill who joined him in 2015, while working collaboratively across the Aviva Investors investment platform. We aim to capture excess returns from across the emerging-market (EM) universe through a deep understanding of specific risks in the asset class and an unbiased and active approach to identifying high-conviction ideas. 

The team also look to benefit from two areas we have bolstered significantly over the years – identifying and assessing sovereigns at risk of distress from liquidity and solvency risk as well as integrating environmental, social and governance (ESG) analysis and sovereign engagement into the research process – a framework we believe is proving effective.

Back when the fund launched in 2003, the asset class was in its infancy. Over the last two decades, the EM investible universe has matured, with a massive increase in the number of issuers and issuance for both sovereign and corporate debt – from around US$2 trillion in 2000 to over $38 trillion in 2021². 

Early on in the market’s history, there were various periods where external shocks showed up deep vulnerabilities among issuers, from the Asian Financial Crisis to Sars, and from the Global Financial Crisis to the Taper Tantrum. While risks remain, the EM universe has become far more resilient in the face of macroeconomic uncertainty and rising rates. Prudent investors may wish to focus on avoiding risks and readying their buy list to generate attractive returns from the asset class.

Five ingredients for success in EMD

In twenty years of running the strategy, we have gained five invaluable insights on how to invest in the EMD asset class through a variety of market conditions. We believe these insights can enhance our ability to deliver consistent risk-adjusted returns for our clients: 

1. Firstly, we believe countries with strong political institutions are best placed to deal with economic and geopolitical shocks, which are a regular occurrence in emerging markets and can matter more than macroeconomic variables in many situations. Integrating ESG analysis into the decision-making process is key. 
2. Alignment of investment strategies with ESG factors and sovereign engagement activities can help mitigate climate and other material risks.
3. When EM debt markets sell off indiscriminately, attractive investment opportunities can be found across the entire hard-currency universe in countries at different points in their credit-quality cycle. Fundamentally driven investors with a focus on the full range of opportunities should be best placed to benefit. 
4. While history matters, countries that defaulted in the past can positively surprise. In other words, today’s risky EM country could well be tomorrow’s opportunity.  A deep understanding of EM risks is key to identifying these opportunities.
5. Finally, it’s important to re-assess your views and address any biases as the opportunity/risk profile evolves as well. Simply because a country has a high credit rating does not mean it has a favourable risk profile. Price matters. We are of the view that concentrating on countries that are meaningful from a risk/reward perspective at the total portfolio level can help to deliver uncorrelated alpha over the long term.

What lies ahead

Looking ahead, we continue to be excited by the opportunity offered in hard-currency EMD despite short-term headwinds, including growth scarring, the costs of financing the energy transition and a more fragmented geopolitical landscape. 

Higher-for-longer US rates makes bottom-up fundamental analysis even more critical. With real rates rising in developed countries, EM nations face being crowded out as they compete for international capital. Those with healthier fiscal metrics and sound macroeconomic policies are best placed to avoid this. Countries that can strike a balance between supporting growth without fuelling inflation and worsening their fiscal metrics should be relatively more attractive.

As for high-yield issuers, avoiding default may come down to their ability to access multilateral finance, willingness to engage with the International Monetary Fund, and whether they have rich friends or opportunities to privatise businesses. That said, while defaults are grabbing, this risk is priced into most countries’ debt.  Our attention is instead focused mainly on those countries at risk of having to pay materially more to issue debt, such as Mexico, which has been battling to keep Pemex, the world’s most indebted oil company, afloat.

We are confident in our team’s approach to deliver uncorrelated alpha with a focus on capital preservation from across the full opportunity set. 

Going into 2024 with a more optimistic view, we will look to capture returns from three main areas. While spreads do not look especially compelling, nominal yields in higher-rated market segments are far from unattractive relative to history. High-yield names with strong fundamentals still offer the potential for decent spread pick-up to treasuries and scope for further spread compression. Lastly, distressed and defaulted debt is also offering value on a selective basis. 

While investors may need a resumption of inflows and stability in core rates to see significant upside potential, countries like Egypt, which we expect to muddle through, and Ecuador, which has been overly penalised for political risk, are some of the names we think could provide interesting opportunities over the medium term. While the asset class faces challenges, we would caution against being too pessimistic on what could prove an excellent entry point.