(Bloomberg) — One of the world’s most prominent emerging-market bears says the correction it has long predicted is just getting started.
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Man Group Plc, the world’s biggest publicly listed hedge fund, took a contrarian stance during an emerging-market rally early this year, predicting a “violent” selloff and arguing that gains were just a reflection of liquidity expansion in the US Treasury’s cash balance. That put it at odds with bullish longer-term views from titans in the industry including Pacific Investment Management Co. and BlackRock Inc.
“We’re entering a period where we are only just starting to see the beginnings of a correction that we talked about,” Lisa Chua, New York-based portfolio manager at Man Group, said in an interview last week. “There is room for another leg of correction on the spread side.”
Emerging-market bonds, currencies and stocks were all set to close another year with losses last week, until Federal Reserve Chairman Jerome Powell sparked an “everything rally” with an address that the market widely interpreted as signaling the US was finished with interest-rate increases. According to Chua, when it comes to emerging markets, that rally is ill-advised.
Fed Pivot
“The recent Fed meeting does not change the emerging-market debt outlook we discussed; namely that rising credit risks are yet to be reflected in spreads,” she said, referring both to investment grade credits, which she said are expensive, and lower-rated credits, which she said aren’t properly pricing rising default risk. Post-Fed, “we are still of the view that spreads are vulnerable to a correction, especially post this latest surge in euphoria.”
In Man Group’s view, the market has grown overly complacent with risks in developing countries as years of excess liquidity begin to be drained from the financial system. With every major central bank hiking interest rates and therefore withdrawing liquidity from the market, bullish emerging-market trades were destined to falter.
So far, that bearishness hasn’t really paid off for them, though. The emerging-market debt fund Chua manages together with Guillermo Osses underperformed most of its peers so far this year, losing 5%, although it beat more than nine out of 10 similar EM bond funds in the three months before last week’s rally, according to data and rankings of 5,506 funds compiled by Bloomberg.
Shares of the London-based firm are up 6% so far this year and assets under management reached a new high at $161.2 billion after clients poured more money into its funds and following its acquisition of private credit firm Varagon Capital Partners.
Reward Improves
The average yield on junk-rated emerging-market dollar bonds rose above 12% last month, returning to levels seen a year earlier, while the new-issuance market has largely closed to riskier names amid intensified default concerns.
“You’re getting a better yield overall, which shows at least that side of the equation has improved,” Chua said. “You still need to be very cautious in terms of where you are investing your money. I think there are some segments of the universe where you definitely need to see spreads widen.”
She said developing countries with floating exchange-rate regimes will have an advantage in responding to macro imbalances by adjusting their currencies and repaying external debt.
“I don’t want to sound all doom and gloom because I think that this will be positive for the asset class” as risk gets priced more appropriately, she said. “It’ll be a very exciting time to enter the asset class at the right time, at the right valuation in a healthier setting. Then you’re finally paid for the risk you are taking, for the first time in a long time.”
Man Group, as a matter of policy, declines to comment on individual countries or investments.
Picking Sides
But there are certain “countries with better balance sheets that can weather a more volatile environment,” Chua said. “Those are the countries that we’ll be looking to add as positioning cleans up and as spreads continue to get more attractive within the high-yield segment.”
Geopolitics are also a factor and “you really need to pick and choose which segments of the high-yield market you are investing in,” she said.
“You need to think about the superpowers of the world basically drawing lines in the sand and picking their sides,” Chua said. “You have the ones that have multilateral support that are more Western-friendly, and also have countries, like some of the frontier Sub-Saharan Africa space, that are in bed with China.”
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