May 16, 2022 | Emerging Markets Debt
Frontier Markets Debt: Underowned and Undercovered
Speaker
Portfolio Manager
Featured Fund
LU2879845290
View Fund:
https://im.williamblair.com/investments/sicav-funds/lu2879845290-emerging-markets-frontier-debt-fund
Featured Strategy
View Strategy:
https://im.williamblair.com/investments/separate-accounts/emerging-markets-frontier-debt
Watch this video online:
https://youtu.be/yJnwQpcwC-w?si=h8oJQqj3TFUA41fR
Transcript
Mike: Hi, everybody. Mike Corcoran with Institutional Investor. Thanks for joining us today with Yvette Babb. And we’re going to be talking with Yvette about why frontier markets matter in emerging market debt strategies right now, and especially interested in fixed-income landscape. Yvette is a hard and local currency portfolio manager on William Blair’s emerging markets debt team. And I think, Yvette, maybe we could start, given the current sort of environment in fixed-income investing, why do you focus on frontier markets in your emerging markets debt hard currency portfolio?
Yvette: Thanks so much, Mike. So, in our view, within an EMD portfolio, we feel the optimal strategic allocation is a combination of emerging market hard currency sovereigns with an overweight in frontiers and an overlay of corporate debt.
And why frontier specifically? This is a part of the emerging market debt universe that is, in our mind, significantly underowned. And that market is also under-covered. And so, the fundamental information is harder to come by.
And we believe that there is a mispricing of risks—i.e. that the actual fundamental premises of default risk in these countries is far lower than it’s actually being priced in times of particular distress.
So, the disconnection of perception of risk and the actual fundamental premise of default risk, in our mind, is where there’s a large amount of value that we as fundamental researchers can unlock. And so, we have a bias towards employing a strategic overweight, given the higher risk premium, higher returns, but actually lower volatility than in global equities over time.
Mike: But I think to a lot of investors, they hear “frontier markets” and they think, “Oh, risky, risky. I’m not.” Can you tell us a little bit about that? What’s your response to that when investors say that, “Oh, feels a little too risky for me”?
Yvette: The truth is, the numbers don’t lie. And if we look at the historical default rates in sovereign and in frontiers specifically, we believe that it uncovers the fact that they are less risky than what’s perceived to be, given that the historical default rate in frontier markets specifically over the period 1995 to 2021 was actually 1.5%.
Another important number to mention in response to that question is that even for those countries that defaulted, that reflected an average default rate of 1.5%, the last given default was further mitigated by the fact that the recovery rates were actually relatively high for those countries that did default. So, the average default rate of that period was 1.5%, as I mentioned, but actually the recovery rate was 55 cents on the dollar.
So, that means that actually, I think, the perception that these countries are unlikely to give healthy returns given the associated risks in those, I think, is very quickly dispelled by these numbers.
I think the second aspect that I’d like to mention is that there are a vast number of frontier markets that we can invest in, which allows us to use a diversified approach—i.e. we have a very strong risk-mitigation strategy that when a country that, due to unforeseen circumstances, does default, we limit the impact on our portfolio by having a very large and diversified holding across frontier markets. So, that diversified approach helps manage the risks of a country eventually facing of those circumstances.
And so, I think the perception of risk is much higher than what the historical rates show and clearly you’re being also, in our mind, very adequately rewarded for taking these risks, given significant yield advantage that these countries have over developed markets, but also versus the investment-grade space and the broader high-yield universe of EMs. And so, it’s a very interesting in our mind sub-universe within the emerging market universe.
Mike: Thanks for those insight, Yvette. As we continue our conversation with Yvette, we’re going to focus on ESG—in particular how it factors into her process and how does it impact when looking at frontier markets and the opportunities therein. So, please join us for that part of the conversation.
Filmed April 2022
The views and opinions expressed herein are those of the speaker(s) as of the date of publication, are subject to change without notice as economic and market conditions dictate and may not reflect the views and opinions of other investment teams within William Blair. Factual information has been obtained from sources we believe to be reliable, but its accuracy, completeness, or interpretation cannot be guaranteed. This material may include estimates, outlooks, projections, and other forward-looking statements. Due to a variety of factors, actual events may differ significantly from those presented. This video has been provided for informational purposes only and should not be considered as investment advice or a recommendation of any particular strategy or investment product, or as an offer to buy or sell any securities or related financial instruments in any jurisdiction. Investment advice and recommendations can be provided only after careful consideration of an investor’s objectives, guidelines, and restrictions. Investing involves risks, including the possible loss of principal. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks. These risks may be enhanced in emerging and frontier markets. Investing in the bond market is subject to certain risks including market, interest rate, issuer, credit, and inflation risk. Rising interest rates generally cause bond prices to fall. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. The inclusion of Environmental, Social and Governance (ESG) factors beyond traditional financial information in the analysis of securities could result in a strategy's performance deviating from other strategies or benchmarks, depending on whether such factors are in or out of favor. Diversification does not ensure against loss. Past performance is not indicative of future results.
Copyright © 2022 William Blair. “William Blair” refers to William Blair Investment Management, LLC. William Blair is a registered trademark of William Blair & Company, L.L.C.
