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About this podcast

Dave Richardson sits down in London with Brent David, Senior Portfolio Manager with BlueBay's emerging-markets debt team to discuss the value of diverse perspectives within an investment team and the strength and evolution of emerging-market debt as an asset class.

Transcript

Welcome to Personally Invested. I'm Dave Richardson. On this episode, I sit down with Brent David in London, England. He's the Senior Portfolio Manager with BlueBay's Emerging-Market Debt Team, and we discuss the value of diverse perspectives within an investment team, and the strength and evolution of Emerging Market Debt as an asset class. I think you'll find Brent's personal story to be particularly interesting, and he's an interesting personality with an interesting perspective on global investing. Enjoy. Brent, welcome to Personally Invested. It's great to have you here.

Thank you, Dave, good to be here.

So, as we have been meeting all the great team here at BlueBay through the week, it's just fascinating, particularly when you're in London, which is just a base for financial services and an investment community, really a global community of investment professionals. You've got people coming from all over with all kinds of different backgrounds. How did you get into this business and into the seat you are in here at BlueBay?

I think, particularly in emerging markets, you obviously then tend to find that a lot of the people who work in the industry come from the markets themselves: So, I'm originally from South Africa, as you may get from the accent.

I just got that.

Sometimes people say I'm quite far from losing the accent, so it's maybe getting stronger and stronger as we go along. But so, I'm originally from South Africa, and originally always worked on the sell-side, so at banks, initially starting at Deutsche Bank. In the day, they had a pretty big operation in South Africa at the time. So, as I graduated from university, I went to Deutsche Bank and started working on their fixed-income desk there. So, always focused on emerging markets, obviously starting with South Africa. Given that it was Deutsche Bank, and given the presence they had around the globe, and then obviously as a base here in London, we had spent a lot of time in London. So, you know, in my first five to six years of my career, I was coming up and down between London and Johannesburg quite often. You know, when there were people leaving from the London office, I'd come up and stay for 6 months to a year, then go back to Johannesburg. So, there was a lot of to-and-fro in the beginning. I then moved to Barclays, which bought a big bank in South Africa at the time, and they were expanding their operation there. So, I initially started based in South Africa building up the operation, but at one point, then, they needed someone to come up to London, more sort of full-time to run the rates trading business. So, that was when I moved to London full-time. And so then started slowly expanding out to other markets across emerging markets but predominantly in this region. So, we're talking about Central and Eastern Europe, the African markets, etc. So, that's then when I moved to London full-time. I moved to BlueBay then in 2014 when BlueBay was looking to expand some of their product sets in the local markets business. Obviously, my background is very specifically on the local-market side, local fixed income and FX markets, but then also expanding into the local credit markets. So, it was a great opportunity. I mean, you know BlueBay just obviously has a fantastic name in emerging markets, so for me, personally, it was a huge opportunity to then delve into the buy-side at a firm that had such a great tradition and name in the emerging-market space to then start expanding in some of the local-market businesses.

And the team you work on is incredible, in that respect. Like, people have come from all over the world. Maybe you can talk about the diversity of the team you have.

Absolutely, I think, if we look roughly, we have about 35 employees on the desk in the emerging markets team focusing on debt in emerging markets across hard currency, local currency sovereigns and corporates. I don't have the numbers on hand, but we have people from a range of different markets. We have myself from South Africa. We have a Zimbabwean on the team. You know, we have people from Turkey. Paulina, who runs the team is from Russia, Armenian background. My background is actually Lebanese. We have people from Asia. We've had people from Latin America. So, really and then, of course, I mean, we obviously do have some people from the U.K.

Yes.

So, you know, it's always bringing together a nice mix of different cultures. When you do that, I mean, you then tend to get very different perspectives. I mean, certainly, given the sort of upbringings that people have had, they look at things from a very, very different perspective. So that is great. It really does add something special and unique to the team, you know. Obviously, it's great when you have a certain amount of conviction on XYZ investment view, but it's even better if you have people with an opposing view or different views bringing in a different perspective and different angle to challenge you on that view. And I think that is what is great about the team that we have. It's big enough in size that you have different perspectives and different views. People are looking at things from a very different perspective, but also from a culturally different perspective and that is pretty special, I'd say, for us. It's definitely something that we like to cultivate and like to hold on to.

Yes and I think, again, after meeting several members of the team and getting an understanding of the way you like to work together and that idea of diverse backgrounds, diverse ideas and actually challenging and interacting and testing each other's thoughts and investment ideas, that it really strengthens the team-that diversity is of value. But, naturally, there is a comfort because of the nature of the team with emerging markets because you were born in an emerging market. You grew up in an emerging market. From a Canadian perspective, and when I talk to Canadian investors, who are very comfortable investing in Canadian government bonds. They might buy a bond of a Canadian bank or a large Canadian company or US company, US government debt, maybe they stray into Europe, but I say "emerging- market debt" and they freak out. This is the craziest, riskiest thing that I could ever touch, and it's such a misconception. Is it not?

I mean absolutely, and, but look, I think we need to think about the starting point. And so, I'm certainly not surprised when you hear people being scared of emerging markets because, obviously through the years and through the decades, emerging markets have gone through particularly tumultuous times during those periods. But I think what's important, and, you know, we come up or investors come up with this, our end investors come up with these kinds of questions all the time as in, "Why should we be investing in emerging markets?" and "What's the opportunity set?" And, "we think it is quite a scary place." So, it's not new that people are thinking about emerging markets like that, but I think the way we like to think about emerging markets is we like to think about the journey that emerging markets has come along. Now, you know, even just by lumping all of them together into one bucket called, "emerging markets" is actually quite a stretch because, you know, the reality is Argentina is a very, very different place to Thailand, with very different issues, some bigger than others. But, on a sort of broad perspective, they are all lumped in this grouping called "emerging markets" and what we've obviously had over the years is that it's gone through a number of different types of crises, right? If we are talking about the Brady bonds from the '80s or the Tequila Crisis in Mexico, and then the Asian Crisis, then Russia and then we have a bit of a boom and then you have the Taper Tantrum. So, we have gone through a number of different crises. But through all of those crises and what has come out is actually an asset class which is stronger than it was previously. And I think that is the way we like to think about it when we think about the journey that emerging markets have come along. If you think about 30 years ago, what you could invest in emerging markets as an international investor, it was traditionally dollar-denominated sovereign bonds. Now, you can invest in sovereigns and corporates in dollars and sovereigns and corporates in local currency. And more and more, you will even start to see emerging markets growing into direct lending type of space or distressed debt type of space, dedicated funds in that space. So, it's evolved very much in terms of the types of products available in the space to investors. And then, when we go and look and say: "okay, so this asset class has evolved and developed and grown and so on and so forth. You then go and look and say, "okay, what is the actual fundamental problem with emerging markets? Why are people so scared about it?" You think. "Okay, so "default rates." Yes, historically default rates were a lot higher, but actually, through the last couple of cycles, default rates have been particularly low in emerging markets and comparable to developed-market type of default rates. So, they...

And that is a really important point.

Absolutely.

Very comparable to developed markets. So, we think we are more secure in Canada, but that is not necessarily the case when, again, you look at it in aggregate more recently.

Absolutely, and not even just more recently, but if you look over the last 10 to 15 years, there was-and we have gone through the Global Financial Crisis and Taper Tantrum through that period-actual default rates in emerging markets have very much been comparable to developed markets. And then the next step you are going to take, and obviously what is very important for fixed-income investors, is the outlook for default rates. But then you are going to look and say: once there are defaults, then what is the recovery rate? You know and how much, how many cents on the dollar do you get back by having gone through the sort of default phase in the emerging market? And it's true that it is lower than U.S. or other comparable developed markets, but not that much lower than you would actually think. So, you actually are very much coming up the scale in terms of your default rates are comparable, your recovery rates are lower, but that gap is converging. And so, from that perspective-and where we see the biggest convergence has actually been in Latin America-so, the part of the world closest to Canadian investors. Historically, that was a lot lower and then over the last-let's call it five years-those recovery rates have been getting better and better. And we continue to expect that to happen as the legal systems become better. Obviously the majority of this debt is issued under international law, but as the sort of the framework within emerging markets helps the sort of default kind of environment, well, those recovery rates have started to improve. So, then you start to look at this and you go, "well actually what do you have here?" You have a fixed-income asset class that your default rates are comparable. Your recovery rates are getting better and better. And, actually, your spreads are quite significantly wider. And more often than not, you'll actually find that if we look at the high-yield space in emerging markets versus the U.S. high-yield space, it's actually higher rated than the U.S. high-yield space because through different idiosyncrasies, it is a little more diversified in EM high-yield, whereas U.S. high-yield is quite sensitive to U.S. oil and gas and the commodity cycle. So, actually, you've got an environment where you have a slightly higher rated asset class with higher spreads and that, then, really does starts to look quite attractive. Then, the other side of that is you have the local markets, and where the local markets has run into its issues of late has been, obviously, the majority of the volatility then comes through the currency channel. Now, this is a catch-22 situation because, if you think back to '97 and the Asian Crisis, what actually happened there, the problem was that a lot of those currencies were pegged to the dollar, and as economies were trying to adjust to different environments, they didn't have that release valve where the currency would then ultimately weaken or strengthen depending on the economic environment and so then, obviously, the environments were getting more and more stressful, but the currency did not adjust. And so, then you had a wave of defaults because the currencies did not adjust. What we have now, 20 years later, is the majority of currencies in emerging markets are free-floating, and the majority of those currencies are then the release valve for when the economy needs to adjust. So, that's an exceptionally good thing for a credit investor, particularly because that just means that you are going to get less and less defaults because your currency is going to do all the work and is going to let your economy adjust. What that means for a currency investor, though, is that you are going to get a lot of volatility in the currencies. Now that comes with opportunities, but it also comes with a lot of risk and a lot of high beta combined. So, when we think about emerging markets, we think about it getting fundamentally stronger as an asset class because it's maturing and developing, currencies are free-floating: they do all the adjustment and the default rates are low and comparable to DM. And then, you get this sort of high-beta component of the asset class, being the currency component of the asset class, which will then go through some very specific cycles, and the cycles will be when there is a strong growth environment in the world and across emerging markets, then currency should perform particularly well. And what is quite exciting, then, for a fixed income investor investing in the currency component of the market is that, actually, if you think about a traditional fixed income versus equity investor, equity is typically your growth channel and that is where you get performance when things are growing. For a fixed-income investor, you just want to ensure that default rates are low. But, actually, when you invest in local currency EM, you actually have a growth channel there. When the world is growing, EM currencies are doing very, very well. So when you are thinking about a broad mix of fixed-income investments, this fits very nicely into a portfolio which is not just about the credit channel, but it's actually also about a potential growth channel, and you get all the upside when the world and, in particular emerging markets, are growing.

Yeah, so there's not just one emerging market. It's a diverse basket of a lot of different countries that have different attributes. That diversification is a strength, which actually makes the asset class much more stable and less risky than a typical Canadian investor would think, which creates opportunity. And then that opportunity is: If I'm looking at a portfolio for an investor in North America, what is the real benefit of having that emerging market exposure in addition to their other exposures and how does that benefit them from a return and risk-management perspective?

So, your immediate obvious one tends to be the pick-up in yield that you will get in emerging markets. So, if we think about the sort of four pillars of emerging markets-so, hard currency, sovereigns and corporates and then local currency sovereigns and corporates-you tend to be getting across all four of them north of 5%, but some of them closer to 10% as a running yield. So, your carry for a developed-market investor is obviously quite substantial if we think about the world we are living in, where some trillions of debt are actually negative-yielding.

And very important for a lot of Canadians and North Americans and Europeans as well who have an aging populations, and people need that yield.

Absolutely. So, from a yield perspective, it looks attractive. Like I said, from a yield-versus-credit-rating perspective and default-rate expectations, it looks attractive relative to its developed-market peers. And then, quite often, what you also then find in emerging markets because it's still more of a developing asset class, broadly versus its developed-market peers, is that you haven't necessarily seen as much duration being issued in the market as you have in developed markets. So, a lot of the components of the asset class are shorter-duration in nature than developed markets. Now, why is it important? Well, in this world, where we are at historically low levels of interest rates, broadly, and, whether you believe it or not, potentially we are moving into a world with higher interest rates, broadly, then actually you have got a shorter-duration asset class with higher yields, and with default rates should be quite low, which actually starts to look quite attractive. And then you get the currency angle, which gives you that higher beta nature to the asset class. We get performance if the world starts really growing and picking up. So, from a broader fixed-income-portfolio perspective, it fits in quite nicely because you actually start to get some yield enhancement, some duration enhancement, shortening duration and then additional beta if growth actually starts to pick up across the world. So, I think it actually does fit in quite nicely. And then, if you think about, well, 50% roughly, of the world's growth is coming from emerging markets. Yet, when we look at typical pension fund portfolios across the globe, we are sitting at around broadly 5% to 6% invested in emerging markets. Well, that's pretty low, right? So, the real opportunity here is for more and more investments to be coming into emerging markets, given that this is becoming the growth channel of the globe. So, from that perspective, those are the sort of more longer-term kind of views out there. But the reality is that as these markets get deeper and deeper, the opening up of emerging markets-like China opening up, India opening up-that just creates opportunities and further opportunities for what are, like you said, the aging population who need to invest, channels for investments to be taking place.

So, they get a higher yield, a similar risk profile, and all these opportunities for future growth. Why don't I put 100% in my portfolio, fixed income portfolio, in emerging markets?

Because it would be higher beta in nature, so it's going to be more volatile than your traditional Canadian fixed-income assets or even U.S. fixed-income assets right now. I mean, U.S. fixed income has actually been quite volatile of late, and so, it's not to say that these markets won't be volatile, but you are going to have periods through the cycles where there is going to be stress in emerging markets, and last year was a great example. So, even though we had come off the back of 2016 and 2017 where you had had a very strong performance from emerging markets, as you move into this environment as we came into in 2018 where everything was looking pretty rosy and quite robust and things were actually performing quite well in emerging markets, you had this period during this summer where trade became a very big concern and that has a material impact then on global growth. And then the Fed was tightening. So, this combination of negative growth and a tightened Fed became particularly worrying for a couple of emerging markets or a couple of big emerging markets in particular who are very dependent on external financing to finance their funding gaps. Argentina and Turkey being the front-and-centre. Now, back to your question as to why not invest all in emerging markets, because, like I said in the beginning, even though I said Argentina is a very different place to Thailand, and they have very different issues, people still lump them all together, and you still tend to have quite a big contagion risk when there is a lot of stress in maybe a select couple of emerging markets: Argentina and Turkey last year being a case in point. But a number of emerging markets came under a significant amount of pressure as investors who have been investing in emerging markets get worried about the sort of knock-on effect into the other emerging markets, the sentiment, and so, therefore, try to sell all their emerging market risk, which puts asset prices under pressure. So, from that perspective, there is still that inherent underlying risk just given this inherent underlying skepticism, sometimes, about emerging markets, and "it's a risky asset so we should sell everything when there is some unique specific problems going on in the world in emerging markets." So, it still has this underlying negative beta when things are going poorly across the globe, but that, in itself, creates opportunities because, for instance, all of this was going on and Brazil sold off very aggressively, but then as people realized that actually Brazil had very, very different financing requirements and needs and they were moving in a positive direction politically in terms of potential for reforms and so on, had a significant rally thereafter because the market came to realize that Brazil had very, very different issues to Argentina at the time. So, from that perspective, it then inherently does also create opportunities for active investors like we are, who then look for those kinds of opportunities when a broader asset class is under so much u pressure, you look for those opportunities to then find the value in those countries or corporates which have very different issues to maybe the pressure points.

And so, Canadians need to be in the space. They need to get over that fear of these markets for all the reasons you have articulated around more stability, diversification, the potential for higher yield in a broadly diversified portfolio. But with the right investment management, because this is not a place for an amateur to be going around to search for the best opportunities.

Absolutely, absolutely, because the reality is that the broader beta is going to have a material impact. But like I said, you need people who know. If we think about what I said about BlueBay, we have 35 specialists in our emerging market team. That is 35 people who are, on a day-to-day basis, looking at country-specific stuff, corporate-specific stuff, how the corporates interlink with the countries, what the policy impact is because, more often than not, it's not just about the economics in emerging markets, it's about the politics too. If we think about, you know, Turkey, for instance, I mean, the politics is a massive driver of what is going on in Turkey at the moment. That impacts economics, impacts decision-making and it impacts then how we invest in Turkey, or not. So, from that perspective, having a team of 35 people who, day-in, day-out, are living and breathing emerging markets and travelling to these countries, seeing the CEOs of these corporates and trying to understand exactly what they are doing to try to ensure that their business is a best place in a changing environment in the sort of macro backdrop of that country is quite critical. And you are right: it's not for amateurs. You have to be living and breathing it day-in and day-out. And so, that is why I do think it's important to be hiring specialists in this space because it's those guys who need to get into the sort of nitty-gritty of the details to really try and understand it.

But with that expertise, you just have to have that in your portfolio. And look, if you are going to look for unstable, or at the very least, very interesting politics as Canadians, we just have to look south of the border and see it's not just emerging markets that have interesting political situations at this point in time.

Exactly, it's a bit of a running joke for us now on the emerging market team, where we feel that there is actually more policy and political risk in developed markets than there is in emerging markets these days. And you know, front-and-centre is the biggest of them all. So, you know, from that perspective, yes, we are seeing that politics is playing a material impact across the globe. We just need to look at Brexit and Trump and the negotiations going on. You know, it's not just us faces political difficulties at any given time. It's happening across the globe. I would probably just categorize that we have been in emerging markets, we have been facing this for a lot longer. It's always been for us in emerging markets, politics has been a critical part of the investment decision for a very long time.

Just a fascinating area of the world and asset class and a fascinating discussion. Brent, thank you so much for your time there.

Excellent! Thank you. It was really good to be here. Thank you, Dave.

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