Unlocking markets: why investors should care about EM

Jan 21, 2025

Phil Langham, Senior Portfolio Manager and Head of our EM Equities Team, and Mike Reed, Head of Global Financial Institutions, discuss emerging markets – an asset class that calls for a skilled active manager with the ability to navigate both the opportunities and challenges. Key talking points include the turning point of EM underperformance, the potential implications of Trump’s White House comeback, why Saudi Arabia is an interesting top-down story, and domestic sectors of interest in the year ahead.

<div class=""> <div class="accordion-wrapper insight-accordion"> <h3></h3> <div class="accordion" id="insightAccordion-51745"> <div class="accordion-item"> <h2 class="accordion-header" id="insightheading"> <button class="accordion-button collapsed" type="button" data-bs-toggle="collapse" data-bs-target="#accordion-51749" aria-expanded="false" aria-controls="collapseOne"> <h5>View transcript</h5> </button> </h2> <div id="accordion-51749" class="accordion-collapse collapse" aria-labelledby="accordionheading" data-bs-parent="#insightAccordion-51745" style=""> <div class="accordion-body"> Unlocking markets: the hunt for high yield By Sid Chhabra, head of European High Yield, Securitized Credit and CLO Management, and Mike Reed, Head of Global Financial Institutions. Mike Reed 00:04 Mike: Hello, and welcome back to Unlocking Markets, the RBC BlueBay podcast, where we bring you experts from across our firm, providing opinions on markets, global policy, sustainability, and macroeconomics, whilst highlighting how these feed into our investment decisions. I'm Mike Reed, head of Global Financial Institutions. Today I'm delighted to welcome Sid Chhabra, head of European High Yield, Securitized Credit and CLO Management here at RBC BlueBay. High yield bonds are often viewed with caution by some investors, but have often generated returns that are greater than those from government or investment grade bonds. It will be interesting to hear from Sid, how he and his team navigate the asset class and generate returns for clients. Sid, welcome to the podcast. Sid Chhabra 00:56 Sid: Hi, Mike. Pleasure to be on. Mike Reed 00:58 Mike: Great to have you. Let's dive in. With core global interest rates having risen from their near-zero levels during the 2010s and Covid era, investors are now able to get much higher coupon rates than back then. Given this, what advantages do high yield bonds or high yield funds bring to investors? Sid Chhabra 01:20 Sid: Yes. If you think about the high yield asset class over the last 5, 10, 15 years, it's consistently delivered 300-400 basis points of excess returns over government bonds. It's not just in relation to government bonds; even compared to corporate investment grade bonds, high yield has delivered 300 basis points or thereabouts of excess returns over the last 3, 5, 7 years. Today, with higher expected rates and a broadly positive backdrop for growth, and also with defaults on the lower end, I continue to see a favourable environment for the asset class to generate strong returns for investors over the next few years. One key point to note is that the asset class has also benefited from a continued improvement in quality over the last decade, because a number of companies within the index are at lower leverage points, which is also reflected in the rating mix, with a growing proportion of these issuers being double B rated. All in all, it's an interesting and a favourable environment for the high yield asset class on a go-forward basis. Mike Reed 02:38 Mike: It's interesting to hear how the returns have been so good over such a long period of time. A lot of the investors we speak to are often very focused over a relatively shorter period of time, and your funds have delivered strong returns over the last 12 months. Given the maybe slightly uncertain current economic backdrop, do you believe they remain attractive here and now today? Sid Chhabra 03:02 Sid: Yes, Mike, very much so, actually. One of the arguments that, of course, investors will mention, is that spreads and valuations have tightened, and they have, but as we touched on earlier, with the benefit of higher base rate and generally, a backdrop of positive growth, we expect to see high single digit returns over the next 12 months. Very attractive, even though it's a little lower than the previous 12 months in this environment. High single digit type of returns, we think, are very compelling. There are a few reasons for that, in terms of how we are able to see that return profile develop. If you think about the supply picture, M&A and LBO volumes are likely to pick up over the next 12 months. We see that as a channel from which we will likely see more supply relative to what we've seen in the last couple of years. Alongside that, there are a number of high yield issuers that still need to refinance their debt. All in all, we expect the supply picture to be healthy over the next 12 months, but that's not it. There's also quite a bit of dispersion between single names in terms of where they're trading, but also within sectors, which, for investors like us, which are active, fundamental, bottom-up credit investors, that provides a very healthy ground for credit alpha generation. This is, as I mentioned, on a backdrop of good growth, stable growth, which means that defaults are not particularly high. In fact, we expect base case defaults to be closer to 2 to 2.5%, many of them coming from well-known idiosyncratic stories. If I put it all together, 2025 is going to be busy for us from a supply side, from a dispersion side, but the carry of the asset class, with high base rates and spreads in the 300-350 basis points range, means that we think it's a potential for a high single digit type of return over the next 12 months. Mike Reed 05:15 Mike: That sounds very interesting, very attractive. I'm going to come back to that point you raised about the dispersion between sectors. Something also you mentioned was you talked about LBOs. I know that with your background, you have a very deep knowledge of leveraged loans. I'd be interested to hear your thoughts on how private credit interacts with the high yield market, and how this has developed, and how this helps your investment process overall. Sid Chhabra 05:42 Sid: Yes, it's a very interesting question, and very topical as well. Firstly, what I would suggest is that the development and growth of the private credit asset class is obviously a positive for corporate issuers, because it gives them an additional channel to source financing and credit. Rather than simply relying on the public channel of, say, high yield bonds or syndicated loans, there is this other channel that is developed and grown. Secondly, private credit tends to offer solutions that typically give the sponsors financing at higher leverage points, many times at six turns or greater leverage versus the high yield market that is, on average, hovering around three turns of leverage. The positive dynamic for the high yield market comes from the growth of private credit asset class and loans, because what's tended to happen is that smaller issuers and mid-scale issuers, owned by PE sponsors, have had this other channel to get credit and financing. They've gravitated towards private credit, which has allowed them, also, to get financing with higher leverage, leaving behind the high yield asset class, which, as I mentioned, is hovering at lower leverage, call it two and a half to three and a half turns, also therefore a higher quality asset class within the broader leveraged finance space. As I mentioned previously, the majority of the index is double B rated, and so, the development and growth of private credit has actually been a positive technical for high yield. Mike Reed 07:16 Mike: That's very interesting. I'm not sure investors are very aware of how the market has developed and this movement, as you said, of the improvement in the credit rating of the index overall has been now double B, and I think that's very important in how investors look at it, going forward, in terms of its risk profile. Now, one thing I said earlier, I was going to come back to, which you touched on with the dispersion across sectors; and so, if you look across the markets today, which sectors do you feel offer particularly good opportunities, in your view and your team’s view, and obviously, which areas are causing you concern? Sid Chhabra 07:53 Sid: Yes. There are a few sectors that we like. We like these sectors for different reasons. For example, banks. Banks continue to report good earnings, strong earnings, and that's translating into improved profitability metrics. We like that sector. On a spread and carry basis, that sector is still trading wide, so we see good opportunities within that sector, and we are investing quite actively within banks and financial services. A different sector that tends to be cyclical, like the energy sector, actually is also providing options for total return, particularly from the new issue market, because there's a lot of refinancing as well as corporate actions which are taking place within that sector. Although being a cyclical sector, it is providing compelling single name return opportunities that help provide alpha within our funds. Telecoms sector, again, a well-known sector, but one that we continue to like, is a sector where there are a few single name issues. By and large, it's a sector that benefits from generally stable revenues that are growing. Within that sector, we have generally focused on those names which have an asset-rich base of infrastructure underlyings. We have taken picks within that sector, where there is an angle beyond just the earning profile. I would say another sector that has had challenges over the last two years that, for us, this year, has been an active hunting ground, has been the real estate sector, and their issuers have had to grapple with higher rates, and previously, financing that was extended at stretched valuations. There's been more stress in the sector over the last 12-24 months, but this year, on the back of lower rates, particularly in Europe, there's been more compelling and interesting opportunities for us to capture value. We have been active in that sector as well. A sector that we are cautious on, and we actually expect stress to develop a bit further, is European autos. We have been expecting lower profitability coming from China for a large number of the European OEMs, but also on the back of lower EV sales. We're starting to see this in earnings. In fact, in the last couple of months, I'm sure many have heard about the weakness, margins, and profitability of the European auto OEMs, as well as suppliers. We don't think this is the end. We expect to remain cautious with, also, potential tariff newsflow picking up as well. We think this will translate to a bit more pressure on margins. Overall, if there was a sector that I would say that we remain somewhat cautious, it is on the European auto side. Mike Reed 10:54 Mike: Thank you. That's very helpful and also helps me because it gives me a lead into my next question. There's a lot of debate of passive versus active. Here at RBC BlueBay, we run active investment strategies very successfully over the years. I'd be interested to know a bit further, a bit more meat on the bones, how does your team actually add value to investors? Sid Chhabra 11:18 Sid: Yes. RBC BlueBay has been investing in the high yield market now for over 20 years. We have a large and very experienced global team. We have something like 20 analysts and over 10 portfolio managers. Actually, many of our analysts and PMs have 15, 20, 25 years of experience. What that means is that many of the issuers within the leveraged finance market, within the high yield market, we have followed their earnings, their performance, through many cycles. That gives us, in our view, an edge, because our team knows these names really well, knows the issuers really well, have understood the dynamics of these issuers extremely well. Alongside that, if you look at our platform today, we have nearly 20 billion in assets that we manage within the leveraged finance cohort across global funds, loan funds, different types of vehicles, benchmark vehicles, as well as total return vehicles. Because of the pace of AUM that we have, we're also very much a key counterparty to sponsors and dealers. When you combine that platform that we have, the size of the team that we have, the experience in the team that we have, and our connectivity with market, including dealers and sponsors, it does give us an edge in the way we express credit views in portfolio construction. That ultimately leads to better longer-term performance. Our value comes, I think, to our investors who allocate with us, because we have a strong base. We have a strong team. We have a global team. We have an experienced team. We have, in my view, a very thoughtful investment process that's been time-tested. It's quite robust. If you put those elements together, ultimately, that leads to strong performance. I think we have generally delivered that over the last 5-10 years. Mike Reed 13:24 Mike: Well, that's very clear. I think investors will see that your team, over the years, has created value for investors and that your active style has definitely outperformed a passive one. Thank you, Sid. It was really great to get your perspective on the high yield market and the current opportunities, and also how you and your team work to generate alpha for investors in our funds. Sid Chhabra 13:48 Sid: Well, thank you, Mike. Thanks for having me. Mike Reed 13:50 Mike: It's been great having you on. Many thanks for listening to the show. If you've enjoyed it, please like and subscribe on your podcast platform of choice. The podcast will be back soon, with more insights from the portfolio managers at RBC BlueBay, which we hope will help you navigate the investment landscape across both equities and fixed income. Thank you, once again, for joining us today. Good luck, and goodbye. </div> </div> </div> </div> </div> </div><div class=""> <div class="accordion-wrapper insight-accordion"> <h3></h3> <div class="accordion" id="insightAccordion-51745"> <div class="accordion-item"> <h2 class="accordion-header" id="insightheading"> <button class="accordion-button collapsed" type="button" data-bs-toggle="collapse" data-bs-target="#accordion-51749" aria-expanded="false" aria-controls="collapseOne"> <h5>View transcript</h5> </button> </h2> <div id="accordion-51749" class="accordion-collapse collapse" aria-labelledby="accordionheading" data-bs-parent="#insightAccordion-51745" style=""> <div class="accordion-body"> Unlocking markets: the hunt for high yield By Sid Chhabra, head of European High Yield, Securitized Credit and CLO Management, and Mike Reed, Head of Global Financial Institutions. Mike Reed 00:04 Mike: Hello, and welcome back to Unlocking Markets, the RBC BlueBay podcast, where we bring you experts from across our firm, providing opinions on markets, global policy, sustainability, and macroeconomics, whilst highlighting how these feed into our investment decisions. I'm Mike Reed, head of Global Financial Institutions. Today I'm delighted to welcome Sid Chhabra, head of European High Yield, Securitized Credit and CLO Management here at RBC BlueBay. High yield bonds are often viewed with caution by some investors, but have often generated returns that are greater than those from government or investment grade bonds. It will be interesting to hear from Sid, how he and his team navigate the asset class and generate returns for clients. Sid, welcome to the podcast. Sid Chhabra 00:56 Sid: Hi, Mike. Pleasure to be on. Mike Reed 00:58 Mike: Great to have you. Let's dive in. With core global interest rates having risen from their near-zero levels during the 2010s and Covid era, investors are now able to get much higher coupon rates than back then. Given this, what advantages do high yield bonds or high yield funds bring to investors? Sid Chhabra 01:20 Sid: Yes. If you think about the high yield asset class over the last 5, 10, 15 years, it's consistently delivered 300-400 basis points of excess returns over government bonds. It's not just in relation to government bonds; even compared to corporate investment grade bonds, high yield has delivered 300 basis points or thereabouts of excess returns over the last 3, 5, 7 years. Today, with higher expected rates and a broadly positive backdrop for growth, and also with defaults on the lower end, I continue to see a favourable environment for the asset class to generate strong returns for investors over the next few years. One key point to note is that the asset class has also benefited from a continued improvement in quality over the last decade, because a number of companies within the index are at lower leverage points, which is also reflected in the rating mix, with a growing proportion of these issuers being double B rated. All in all, it's an interesting and a favourable environment for the high yield asset class on a go-forward basis. Mike Reed 02:38 Mike: It's interesting to hear how the returns have been so good over such a long period of time. A lot of the investors we speak to are often very focused over a relatively shorter period of time, and your funds have delivered strong returns over the last 12 months. Given the maybe slightly uncertain current economic backdrop, do you believe they remain attractive here and now today? Sid Chhabra 03:02 Sid: Yes, Mike, very much so, actually. One of the arguments that, of course, investors will mention, is that spreads and valuations have tightened, and they have, but as we touched on earlier, with the benefit of higher base rate and generally, a backdrop of positive growth, we expect to see high single digit returns over the next 12 months. Very attractive, even though it's a little lower than the previous 12 months in this environment. High single digit type of returns, we think, are very compelling. There are a few reasons for that, in terms of how we are able to see that return profile develop. If you think about the supply picture, M&A and LBO volumes are likely to pick up over the next 12 months. We see that as a channel from which we will likely see more supply relative to what we've seen in the last couple of years. Alongside that, there are a number of high yield issuers that still need to refinance their debt. All in all, we expect the supply picture to be healthy over the next 12 months, but that's not it. There's also quite a bit of dispersion between single names in terms of where they're trading, but also within sectors, which, for investors like us, which are active, fundamental, bottom-up credit investors, that provides a very healthy ground for credit alpha generation. This is, as I mentioned, on a backdrop of good growth, stable growth, which means that defaults are not particularly high. In fact, we expect base case defaults to be closer to 2 to 2.5%, many of them coming from well-known idiosyncratic stories. If I put it all together, 2025 is going to be busy for us from a supply side, from a dispersion side, but the carry of the asset class, with high base rates and spreads in the 300-350 basis points range, means that we think it's a potential for a high single digit type of return over the next 12 months. Mike Reed 05:15 Mike: That sounds very interesting, very attractive. I'm going to come back to that point you raised about the dispersion between sectors. Something also you mentioned was you talked about LBOs. I know that with your background, you have a very deep knowledge of leveraged loans. I'd be interested to hear your thoughts on how private credit interacts with the high yield market, and how this has developed, and how this helps your investment process overall. Sid Chhabra 05:42 Sid: Yes, it's a very interesting question, and very topical as well. Firstly, what I would suggest is that the development and growth of the private credit asset class is obviously a positive for corporate issuers, because it gives them an additional channel to source financing and credit. Rather than simply relying on the public channel of, say, high yield bonds or syndicated loans, there is this other channel that is developed and grown. Secondly, private credit tends to offer solutions that typically give the sponsors financing at higher leverage points, many times at six turns or greater leverage versus the high yield market that is, on average, hovering around three turns of leverage. The positive dynamic for the high yield market comes from the growth of private credit asset class and loans, because what's tended to happen is that smaller issuers and mid-scale issuers, owned by PE sponsors, have had this other channel to get credit and financing. They've gravitated towards private credit, which has allowed them, also, to get financing with higher leverage, leaving behind the high yield asset class, which, as I mentioned, is hovering at lower leverage, call it two and a half to three and a half turns, also therefore a higher quality asset class within the broader leveraged finance space. As I mentioned previously, the majority of the index is double B rated, and so, the development and growth of private credit has actually been a positive technical for high yield. Mike Reed 07:16 Mike: That's very interesting. I'm not sure investors are very aware of how the market has developed and this movement, as you said, of the improvement in the credit rating of the index overall has been now double B, and I think that's very important in how investors look at it, going forward, in terms of its risk profile. Now, one thing I said earlier, I was going to come back to, which you touched on with the dispersion across sectors; and so, if you look across the markets today, which sectors do you feel offer particularly good opportunities, in your view and your team’s view, and obviously, which areas are causing you concern? Sid Chhabra 07:53 Sid: Yes. There are a few sectors that we like. We like these sectors for different reasons. For example, banks. Banks continue to report good earnings, strong earnings, and that's translating into improved profitability metrics. We like that sector. On a spread and carry basis, that sector is still trading wide, so we see good opportunities within that sector, and we are investing quite actively within banks and financial services. A different sector that tends to be cyclical, like the energy sector, actually is also providing options for total return, particularly from the new issue market, because there's a lot of refinancing as well as corporate actions which are taking place within that sector. Although being a cyclical sector, it is providing compelling single name return opportunities that help provide alpha within our funds. Telecoms sector, again, a well-known sector, but one that we continue to like, is a sector where there are a few single name issues. By and large, it's a sector that benefits from generally stable revenues that are growing. Within that sector, we have generally focused on those names which have an asset-rich base of infrastructure underlyings. We have taken picks within that sector, where there is an angle beyond just the earning profile. I would say another sector that has had challenges over the last two years that, for us, this year, has been an active hunting ground, has been the real estate sector, and their issuers have had to grapple with higher rates, and previously, financing that was extended at stretched valuations. There's been more stress in the sector over the last 12-24 months, but this year, on the back of lower rates, particularly in Europe, there's been more compelling and interesting opportunities for us to capture value. We have been active in that sector as well. A sector that we are cautious on, and we actually expect stress to develop a bit further, is European autos. We have been expecting lower profitability coming from China for a large number of the European OEMs, but also on the back of lower EV sales. We're starting to see this in earnings. In fact, in the last couple of months, I'm sure many have heard about the weakness, margins, and profitability of the European auto OEMs, as well as suppliers. We don't think this is the end. We expect to remain cautious with, also, potential tariff newsflow picking up as well. We think this will translate to a bit more pressure on margins. Overall, if there was a sector that I would say that we remain somewhat cautious, it is on the European auto side. Mike Reed 10:54 Mike: Thank you. That's very helpful and also helps me because it gives me a lead into my next question. There's a lot of debate of passive versus active. Here at RBC BlueBay, we run active investment strategies very successfully over the years. I'd be interested to know a bit further, a bit more meat on the bones, how does your team actually add value to investors? Sid Chhabra 11:18 Sid: Yes. RBC BlueBay has been investing in the high yield market now for over 20 years. We have a large and very experienced global team. We have something like 20 analysts and over 10 portfolio managers. Actually, many of our analysts and PMs have 15, 20, 25 years of experience. What that means is that many of the issuers within the leveraged finance market, within the high yield market, we have followed their earnings, their performance, through many cycles. That gives us, in our view, an edge, because our team knows these names really well, knows the issuers really well, have understood the dynamics of these issuers extremely well. Alongside that, if you look at our platform today, we have nearly 20 billion in assets that we manage within the leveraged finance cohort across global funds, loan funds, different types of vehicles, benchmark vehicles, as well as total return vehicles. Because of the pace of AUM that we have, we're also very much a key counterparty to sponsors and dealers. When you combine that platform that we have, the size of the team that we have, the experience in the team that we have, and our connectivity with market, including dealers and sponsors, it does give us an edge in the way we express credit views in portfolio construction. That ultimately leads to better longer-term performance. Our value comes, I think, to our investors who allocate with us, because we have a strong base. We have a strong team. We have a global team. We have an experienced team. We have, in my view, a very thoughtful investment process that's been time-tested. It's quite robust. If you put those elements together, ultimately, that leads to strong performance. I think we have generally delivered that over the last 5-10 years. Mike Reed 13:24 Mike: Well, that's very clear. I think investors will see that your team, over the years, has created value for investors and that your active style has definitely outperformed a passive one. Thank you, Sid. It was really great to get your perspective on the high yield market and the current opportunities, and also how you and your team work to generate alpha for investors in our funds. Sid Chhabra 13:48 Sid: Well, thank you, Mike. Thanks for having me. Mike Reed 13:50 Mike: It's been great having you on. Many thanks for listening to the show. If you've enjoyed it, please like and subscribe on your podcast platform of choice. The podcast will be back soon, with more insights from the portfolio managers at RBC BlueBay, which we hope will help you navigate the investment landscape across both equities and fixed income. Thank you, once again, for joining us today. Good luck, and goodbye. </div> </div> </div> </div> </div> </div>_

Unlocking markets: why investors should care about EM

By Phil Langham, Senior Portfolio Manager and Head of our EM Equities Team, and Mike Reed, Head of Global Financial Institutions.

Mike Reed 00:04
Hello and welcome back to Unlocking Markets, our RBC BlueBay podcast series. This is where we bring you experts from across the firm, provide their opinions on the macro environment, and discuss how top-down themes help influence the way they invest. I'm Mike Reed, Head of Global Financial Institutions.

Today I'm going to be talking to Phil Langham, who is both a Senior Portfolio Manager and Head of our Emerging Markets Equities team. The term emerging markets covers a broad and disparate group of countries with very different economies. This can make investing in them quite challenging. In today's podcast, we'll be covering a range of topics that we believe all investors involved in EM equities should be thinking about right now. Welcome, Phil.

Phil Langham 00:48
Thank you, Mike.

Mike Reed 00:50
Kicking off, as investors, we are often reminded that there is no direct linkage between GDP growth and stock market performance. This lack of correlation has been particularly stark within emerging markets versus their developed peers over the last decade, as EM equities have significantly underperformed despite strong economic growth. The obvious question I often hear from clients is, why should now be different?

Phil Langham 01:16
It's interesting. If you look at the relative performance of emerging markets compared to developed markets over the last 40 years, what we've seen is that relative performance tends to occur in very long cycles that have lasted around 8 to 12 years. The last cycle of EM underperformance or the current cycle of EM underperformance has been particularly stark in terms of its length, currently at around 13 years. Why should 2025 be any different?

It's always difficult to pinpoint exact turning points, but a few reasons why we think that we are approaching the turning points of emerging market underperformance would be, first of all, relative earnings and relative GDP growth. If we look at most of the last decade, we have seen that earnings growth has been disappointing in emerging markets and relative GDP growth has also been coming off. That seems to be changing both in terms of relative GDP growth, which is starting to improve, but also earnings growth over the next two years for emerging markets is expected to be stronger than for developed markets.

Secondly, China. China, particularly in the last three years, has been a significant overhang for emerging markets, and at its peak represented about 44% of the emerging market equity index. It's been weak for a number of different reasons, but we would say the most important reason has been government or lack of government support for the economy. That seems to be changing. Certainly, the rhetoric that we're hearing coming out from China would seem to suggest that we're starting to see significant support both for the private sector and for the economy. We're starting to see meaningful signs that that should have an impact overall on the market.

The third factor is valuation. Now, while valuation isn't a very good timing tool, we do see that emerging markets, both in P/E terms and price-to-book terms, are at record lows compared to developed markets. In P/E terms, at around a 40% discount, in price-to-book terms, at around a 50% discount.

Mike Reed 03:55
Those all sound quite compelling arguments, but I guess one of the pushbacks will be what's happening in the US. Donald Trump has now been reinstated as President of the United States, and there's been a lot of talk of tariffs, which I suspect could significantly impact many emerging market countries who rely heavily on exports to the US. What implications do you expect from his presidency, and how are you positioning your funds to both protect and profit from the anticipated changes?

Phil Langham 04:24
Yes, you're right. Donald Trump has certainly been talking about implementing tariffs. It's not clear exactly in what form these tariffs will come. Initially, certainly, there was a lot of talk of universal tariffs, but increasingly, it seems to be the case that these tariffs are more likely to be targeted and more likely to be used as a negotiating tool. What's interesting is that if we look at what's happened to emerging markets overall, since we first started seeing the trade war when Trump was first elected, we see overall that there's been relatively mixed fortunes, but for the most part, emerging markets have actually navigated the trade war quite well.

First of all, looking at China, which would seem to be the country that's the most impacted, if we looked at what's happened to China in terms of trade in recent years, we've seen that exports as a percentage of GDP to the US have fallen from around 20% to around 15%. At the same time, we've seen huge growth in exports to other emerging markets. We're actually seeing China's exports overall as a share of global exports increase, and China is seeing record trade surpluses.

We've also seen a lot of other emerging markets benefit, as manufacturing has moved away from China to other EMs, such as those in Southeast Asia and Mexico. The picture isn't entirely clear. In terms of what we're doing, we still feel that it makes sense to be somewhat cautious on exporting industries, and certainly those that are more linked to manufacturing. We tend to favor more domestic industries and those that can grow from the domestic demand growth within emerging markets.

Mike Reed 06:30
That's an interesting take, and to see how you're actually thinking about the interlinking of the emerging markets more broadly, rather than just seeing them as a supplier to, say, the G7. I guess segueing, but still sitting with the US, the fortunes of emerging market equities are often linked to the strength or weakness of the US dollar. Over recent years, the dollar has been very strong, and this has been identified as one of the causes of EM equity underperformance. Is this a fair assessment, and how do you envisage the US rate cycle over the next 12, 18 months will impact emerging markets going forward?

Phil Langham 07:23
Yes, it is a completely fair assessment. What we've seen historically is that there is a very strong link between the performance of the US dollar and the relative performance of emerging markets. Generally, emerging markets do much better in a weak US dollar environment. For example, we saw between 2001 and 2010, when the dollar was weak, emerging market relative performance was very strong, and vice versa in the last 12 years. We've had a very unusual period or unusually long periods of dollar strength in the last 11 or 12 years.

Definitely, as you touch on, one of the factors that will impact the dollar is the US rate cycle. In terms of where we go from here, generally, what we would expect is that lower rates would lead to a weaker dollar. It's really unclear exactly where we are in terms of the US rate cycle. Certainly, there are some people who fear that there could be more US inflation, and that may mean that US rates don't continue to fall as much as some market participants would expect. What we saw last year was that the initial reaction to Donald Trump being elected was further US dollar strength.

Our view, though, would be that from here, there are a number of reasons why we would feel that the US dollar may actually start to weaken over coming years.

First of all, valuation. If we look at the US dollar, it really is looking extremely expensive on most valuation measures.

Secondly, the US has a growing current account and fiscal deficit. That compares to emerging markets where you see very large current account surpluses.

Thirdly, if we look at Donald Trump's overall policy, he very much wants to see US industry become more competitive and would like to see a weaker US dollar. The dollar strength that we've seen recently very much goes against the sort of policy that he would like going forward.

Mike Reed 10:00
It's interesting there, but what I'd like to look at now is some of the geopolitical issues and we've seen tensions appearing to rise. We have conflict in the Middle East and in Ukraine and some growing worries in the South China Sea with Taiwan and China. Within EM economies, who do you believe are the winners and losers out of where we are now, or where you foresee?

Phil Langham 10:25
Geopolitical tensions have certainly risen over recent years. What we've often seen historically is that markets in the short term can overreact to geopolitical tensions. In terms of the two big ones that we see at the moment, so the Russia-Ukraine war and Middle East, what's interesting is that outside of Russia, the Russia-Ukraine war has been relatively contained and, in many ways, some emerging markets have really benefited from lower oil prices as Russia has started exporting oil to countries such as India and China.

In terms of the Middle East, we've seen that the impact has been again relatively contained. We have seen some weakness in Middle Eastern consumer markets, but outside of that, the impact again has been relatively contained. I'd say that in terms of both conflicts, our view would be that the most likely outcome would be perhaps more of the status quo. In terms of emerging markets overall, the risk would really be, in terms of geopolitical events; if we were to see an extended elevated period of a higher oil price but that hasn't been the case in recent years. If we were to see that, that's where we would start to see or that's where we would start to have an impact.

The markets that would be particularly affected would be obviously the big oil importers, particularly those in Asia countries, such as India, also Turkey would be another very large oil importer.

Mike Reed 12:24
Let's move on from the big picture now and let's go into something a little bit more granular. You touched on a couple of sectors earlier in the conversation, which you liked and, I don't know, which one you were trying to avoid, but maybe can we dig in a little deeper within that? Within emerging markets, where are you and your team most excited about today? Where do you really see the winners are going to come?

Phil Langham 12:47
Well, we do like, as I touched on earlier, domestic sectors, which benefit from rising incomes, demographics, urbanisation, the reforms that we're seeing. I'd say within domestic sectors, we particularly like two sectors. First of all, consumer staples. Consumer staples have derated in recent years, and from a valuation perspective, look very attractive currently. We also tend to like a lot of the qualities of consumer staple stocks. They tend to be very cash-generative, have high returns, strong brands, very steady growth.

Another sector that I'd say we like is financials. Within emerging markets, there's a real structural theme in financials in terms of relatively low penetration. Also, one of the attractions that we see within the financial sector is that the very best financials, so the best banks or the best insurance companies really may be able to maintain their competitive advantage over very long periods of time. A second factor that we would say really supports financials for emerging markets is that we generally see within emerging markets very high real rates. As interest rates are expected to come down in emerging markets, the sector that will perhaps benefit the most will be financials.

Mike Reed 14:25
Again, it's great to hear more granular type thoughts on what you're actually doing. We talked about the Middle East and we talked about it in a slightly more negative terms, in terms of the conflicts there. It does continue to grow in economic terms and is becoming an increasing weight, I believe, in EM equity benchmarks, so you'll be focusing on it more. We've also witnessed the region's attempts to diversify away from reliance on hydrocarbons into sectors such as leisure, transport, financial services, even in sport now. What are your thoughts on opportunities in the region?

Phil Langham 15:03
Yes. You're right. We've seen the Middle Eastern weight within emerging markets substantially increase in recent years. Now it represents around 7% of the overall weight for emerging markets equities.

In terms of reforms, we are seeing reforms throughout the Middle East, but particularly in Saudi Arabia. Saudi Arabia, I'd say, has been quite successful so far in terms of diversifying away from oil. Currently, non-oil GDP as a percentage of overall GDP is around 50%. We're also seeing a number of other reforms that are really helping overall growth. A good example within Saudi Arabia would be female participation within the workforce, which has grown, again, quite substantially, and is now at about 35%.

Overall, we would say that the top-down outlook for the Middle East, as a result of a lot of these reforms, looks pretty strong. Our main concern with the Middle East is more from a bottom-up point of view. We do feel that when we look at a lot of the stocks, that the quality of stocks still isn't the same as we see outside of a region. The quality of management, the quality of corporate governors, the earnings quality overall, and our main caution on the Middle East is more from a bottom-up point of view than from a top-down point of view.

Mike Reed 16:49
Well, I'd like to expand on that governance you just touched on there, but more broadly across the sector and across the whole of EM. ESG factors have become a major focus for many investors, and particularly here in Europe. Emerging markets would, I guess, on first sight appear to offer considerable challenges in this area. I know your funds are well-known for the way you integrate ESG into your investment processes. Perhaps you could shed some light on the main challenges you experience and how you navigate them.

Phil Langham 17:24
Yes, sure. It's interesting when it comes to ESG. ESG has obviously really taken off over the last three, four, five years. For us, it's always been an important part of what we do. Our funds haven't changed their process since we started 15 years ago. For us, ESG has always been really key in terms of what we look for, and we think it is particularly important in emerging markets.

What we find is that companies that pay attention to ESG tend to be companies that have a strong culture, a real culture of excellence. They're companies that think long-term, that don't take shortcuts. They're companies that don't take the same risks and therefore don't face the same problems as competitors. They're companies where employees tend to be much more engaged and therefore much more productive. All factors that we feel lead to higher and more sustainable returns, and that is exactly what we look for.

As you touch on, there are challenges within emerging markets, particularly in terms of data quality, and we do feel that as a result, it's very difficult when looking at emerging markets to rely on third-party providers. For that reason, we feel and we've always felt that it's absolutely crucial that we do the work ourselves, that we meet companies ourselves, but we are focused on all these issues ourselves, and we're not reliant on other data sources.

Mike Reed 19:01
Thanks, Phil. That was great. It's clear that the ever-evolving social and economic landscape makes this a hugely compelling asset for us. I'm sure that the coming year will continue to bring a wealth of discussion points, so thank you very much. It's been really interesting hearing your thoughts and understanding how you and your team intend to generate returns for clients in what sounds like markets full of alpha-generating opportunities.

Phil Langham 19:24
Great. thank you very much, Mike.

Mike Reed 19:26
I hope you've enjoyed today's show. Please like and subscribe on your podcast platform of choice. We will be out next month, where we'll be continuing our focus on emerging markets, but moving on to the fixed-income part of the universe. We will be joined by Anthony Kettle from the RBC BlueBay EM Debt team. If you wish to listen to any of the previous editions of the Unlocking Markets podcast, they are available on our website www.bluebay.com, or can be found on Apple, Spotify, or Google. Thank you very much for listening. Goodbye.

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Unlocking markets: why investors should care about EM

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EM equities: when challenges become opportunities

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EM equities: when challenges become opportunities

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Argentina: is this time different?

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