The complicated geopolitical landscape of the past few years has soured some on investment in emerging markets whilst while other have doubled down, depending on their individual needs.
The wider surrounding issues – such as how insurance investment strategies are adapting against the backdrop of conflicting macro versus micro data, as well as the state of the commercial real estate debt and equity space – were discussed by panellists at the Insurance Investor Live | North America event in December last year in New York, which is now featured in the Insurance Asset Management North America 2024 report.
Contributing to the discussion were Laura Sarlo, Emerging Markets Portfolio Manager, Liberty Mutual Insurance, as well as representatives from Converge US, Shelter Insurance, and T. Rowe Price – with Nelson Pereira, Investment Director, Insurance, Mercer, moderating.
Pereira opened the debate by asking the panellists if they were engaging with emerging markets investments. If so, he asked, what was their current strategy? The discussion if current investment strategies came back to the opportunity set and how the income component was “core”. “Perhaps having the right discussion and doing the right due diligence can provide the right opportunities,” Pereira said.
Other panellists agreed. They were investing in emerging markets as part of this opportunity set – but only on the debts side. “It is a small sliver of the portfolio, it has added to the diversification of our overall portfolio, and we wanted a more corporate-type of exposure,” said one. Emerging markets – which, from an interest spread, pick up per credit quality – made a lot of sense. It was, however, volatile, and “things get in the news, which is not pleasant,” the panellists added.
"If growth doesn’t collapse, and we don’t have some calamitous recession, then people will want to look at what else is out there."
Sarlo said this situation was indicative of much trouble investors had with emerging markets. “People have that experience [of volatility], and they ask why they are in this asset class, and then investor interest goes quiet,” she said. “In emerging markets right now, because it has been unloved, foreign ownership of local currency bonds is at a ten-year low across a lot of countries. We don’t see a lot of crossover US investors in emerging markets right now.”
“This will change because emerging markets assets delivered strong returns in Q4, and that will catch everyone’s attention over the next couple of months as we get into 2024 and start thinking about the Fed cutting rates. If growth doesn’t collapse, and we don’t have some calamitous recession, then people will want to look at what else is out there,” Sarlo added.
She said that in emerging markets hard currency debt spreads on bonds from “the big liquid BB – and better-rated emerging markets issuers” had ratcheted in with US corporate spreads. “This is the safe zone of emerging markets; it has been in favour these last few weeks and has benefited from being a long-duration asset,” she said.
“While these frontier markets were in favour a few years back, they’ve been struggling since the pandemic.”
Sarlo also said there was the deep end of the pool – the B and CCC issuers – to consider. “These are issuers who have not had market access for the last couple of years, and they are the ones that are most often in the news for things like restructurings or defaults,” she said. “While these frontier markets were in favour a few years back, they’ve been struggling since the pandemic.”
She added that these issuers were still struggling with no market access and with the “drying up of investment from the Chinese Belt and Road Initiative.” She continued: “Investors in those markets need to understand the capital stack carefully because there is not a lot of transparency.”
You can read more of Sarlo’s thoughts on the outlook for emerging markets in 2024 below:
Laura Sarlo: Beyond what is happening on the front page of the paper every day, we are looking at many geopolitical events, including eight successful and four failed coups across Sub-Saharan Africa. As of December 2023, many regional disputes involving China’s neighbours, and most recently the building tension between China and the Philippines.
"You want to build your portfolio for as many scenarios across as wide a distribution as possible."
Markets are always dealing with geopolitical issues and risks, and so we have to build out portfolios to be conscious of that.
We have seen a lot of volatility from supposedly risk-free assets in 2023, so we think about what kinds of risks we are taking, considering rate, credit and liquidity risks in careful ways, and this is always the best plan. You want to build your portfolio for as many scenarios across as wide a distribution as possible.
Laura: To the point about doing your homework on different asset classes, you need to understand what it is that you are buying. Particularly if you are talking about another manager, you need to understand where they are investing and where their allocations are.
In emerging markets, you also want to consider debt sustainability – so what are the countries that can handle higher interest rates? How are they making room in their budgets? Are there other priorities that have to shift if you suddenly have higher interest rate costs to bear, whether they are in local currencies or dollars? Last year, we only saw limited consolidation of fiscal deficits, and it is better in emerging markets than it is in the US.
In terms of policy-making, we have seen a number of populist trends in the US and within emerging markets. Sometimes, this results in bad policy, so when we talk about ESG we are not just talking about small island countries at greatest risk from climate change; we are talking about those bonds and issuers that have demonstrated good governance and quality economic policy-making.
"This is why I care a lot about the countries that have their own domestic demand engines and are doing a lot more trade across the global south."
Their stability throughout the elections that Thomas Hoenig mentioned – there are 70 elections in 2024 – is key, and the question is whether you can see your way to a stable set of sound economic policies that get you through that period. This is what you want to look for when you are thinking about allocating to different countries globally.
Historically, emerging markets offers a different return profile from US corporates, which is a nice thing to have, and we talk a lot about the growing share of the population and global GDP in emerging markets. The natural question people have is how global economies fare amidst the structural slowdown in China. This is why I care a lot about the countries that have their own domestic demand engines and are doing a lot more trade across the global south – as well as those benefiting from global supply chain diversification.
These are some of the factors that I think can make the emerging markets story more durable than just using it as a China or US growth proxy.
