Charles de Quinsonas: ‘We remain optimistic about 2024’

There has been no shortage of surprises in the bond market in 2023 – but perhaps the most unexpected result has been in emerging markets, according to Charles de Quinsonas.

‘[Alongside US high yield] EM local currency bonds have been the best fixed income asset class in 2023’ says de Quinsonas, who runs M&G Investments Emerging Markets Bond Fund.

‘Yes, it’s a bit counterintuitive,’ he says. ‘Earlier this year, no one would have bet on EM local bonds with rising US rates. 

‘I’m pretty sure if you had asked ChatGPT at the beginning of 2023, ‘Is it a good idea to invest in EM bonds with rising interest rates in the US?’ it would have said no.’

As he points out, history would have given you the same answer. He indicates to 2013 when Ben Bernanke, then the chair of the US Federal Reserve, said that the central bank would begin tapering asset purchases at some point.

Bond yields rose everywhere leading to three years of underperformance of emerging market local bonds. However, the story is very different today, he says, mentioning how the people running the monetary systems in these markets have reacted far better this time. 

‘Emerging market central banks back then were not proactive – they were late, behind the curve. So, they had to hike after the Fed did. 

‘This time around it was, and still is, a very different situation. EM central bankers have learnt their lessons. They’ve hiked well in advance of the Fed. Nominal yields in many emerging markets were and are still, very elevated,’ he added. 

Not only are they elevated, but these nominal yields also stand above local inflation rates, giving what he describes as ‘decent real yields’ on local issues in countries, such as Colombia, Brazil, South Africa, and Mexico.

That real yield advantage over developed markets has diminished of late and de Quinsonas is adjusting his portfolio accordingly. He is trimming his outperforming Latin American holdings and closing underweight positions in eastern and central Europe. 

M&G Investments EMD team has two underlying principles in constructing his portfolio. The first is to evaluate each country on a case-by-case basis, rather than just taking a cue from the perceived direction of the dollar and applying a blanket position. 

‘I think it’s very tricky to take a view on the dollar and go big local or underweight local. That’s no how we do it. 

‘What I’m trying to say here is that we find value in a local market and make that our base case, without having a very strong view on where the dollar or the Fed is going. So, we think there is still some room for that rally.’ 

This means being very selective in choosing markets, especially as one consequence of a high-interest-rate world is making market access harder for weaker borrowers. 

‘Some countries, in sub-Saharan Africa, but more generally frontier markets, don’t have the depth of the local markets. So, they will need to tap the dollar bond market. 

This may find much harder to do this time around. ‘For good or for bad, they were allowed to do that in a low-yielding world. So higher rates for longer is bad, primarily for the weakest credit in EM, clearly.’

The second underpinning of his portfolio is to make sure it’s very diversified in case of unexpected events – such as the conflict in Israel happening now or the potential further ahead for China to reclaim Taiwan. 

‘The only way to tackle tail risk within the portfolio in EM debt is diversification. The other way is thinking you’re smarter than anybody else and that’s not what we think. 

‘So over time for long-term performance, you have to be diverse to minimise the potential of the tail risks. Our top 10 overweights are actually very, very small weights.’ 

As well as regarding geopolitics as a tail risk, rather than a specific problem for emerging markets, de Quinsonas also believes headline default numbers for the asset class – 14% for high yield – should not be taken at face value, or as an excuse to avoid the asset class. 

He points out that if you remove Russia, Ukraine, and China property from that 14% number, then it’s more like 1.8%.

He admits that, just as in the US and in Europe, we’ll see default rates in emerging markets picking up as part of the current economic cycle. This trend is prompting another adjustment in the hard currency portion of the portfolio.

‘We favour the high-yield sovereign issues, and we are a little bit higher in credit quality in the corporate space because of higher default rates,’ he says. 

In general, he remains optimistic about 2024, bearing in mind that there may be some surprises arising from global monetary policy and inflation. 

‘Our base case remains that we are closer to a pivot than rates going up significantly anyway. So, in terms of how we skew the portfolio, we probably have a positive view right now,’ he added. 

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Investments in bonds are affected by interest rates, inflation and credit ratings. It is possible that bond issuers will not pay interest or return the capital. All of these events can reduce the value of bonds held by the fund.

The fund is exposed to different currencies. Derivatives are used to minimise, but may not always eliminate, the impact of movements in currency exchange rates.

Investing in emerging markets involves a greater risk of loss due to greater political, tax, economic, foreign exchange, liquidity and regulatory risks, among other factors. There may be difficulties in buying, selling, safekeeping or valuing investments in such countries.

The information provided should not be considered a recommendation to purchase or sell any particular security. The views expressed in this document should not be taken as a recommendation, advice or forecast.