MFS® Emerging Markets Debt Strategy - Quarterly Portfolio Update

Title: MFS® Emerging Markets Debt Strategy - Quarterly Portfolio Update

Abstract: Katrina Uzun, Institutional Portfolio Manager, shares the team's thoughts on emerging markets and provides a quarterly update on the Emerging Markets Debt Strategy.

 

Hello, and thank you for taking a few minutes to hear about the Emerging Markets Debt. I am Katrina Uzun, an institutional portfolio manager overseeing the Emerging Markets Debt strategies at MFS, and I wanted to take this time to share our perspectives on the global macro environment and high-level portfolio positioning.

 

The fourth quarter of last year saw a strong risk-on phase, helped by resilient growth and rapid disinflation. The Fed ended its 500 basis points tightening cycle last July and then made an important pivot in November by signaling interest rate cuts in 2024. That caused a risk rally in November and December. Both the emerging markets hard and local currency debt indices produced strong positive total returns with positive 9% and positive 8% respectively. 

 

For the full year, however, the lower-rated CCC and below component of the hard currency index drove the bulk of the return, with the lower-rated sovereigns rallying over 40% versus the benchmark’s 11% return. For EM local currency, about 10% came from rates for the full year, which were supported by the easing cycles across most of the emerging markets’ economies and only about 2% from FX, which face some headwinds from the stronger USD and US exceptionalism trend.

 

We are relatively constructive on our outlook in emerging markets debt as the overall external backdrop appears more favorable. Central banks in many emerging market economies have navigated this economic cycle well, with inflation in most countries now trending back towards target levels. As a result, many emerging market central banks have started cutting rates, and many developed markets central banks are likely to start cutting this year.

 

The fundamentals of emerging markets debt remain robust, marked by strong external accounts. Despite the rise in emerging markets public debt to GDP, it remains significantly lower compared to developed countries. On top of it, emerging markets debt is primarily denominated in local currencies and concentrated in the private sector, mostly in China.

 

The challenge in emerging markets, as well as many other markets, both equity and fixed income, stems from tight valuations. Emerging markets debt spreads are at historically tight levels if the most speculative countries, CCC and below, are excluded from the benchmark.

 

Another challenge that stood out last year was the disappointing growth in China as structural factors remain a long-term headwind. We expect a modest pickup in growth in China this year as the government is providing some policy stimulus to support the economic recovery. Fixed asset investment — investment in infrastructure — is picking up thanks to these stimulus efforts, but consumption remains weak and manufacturing PMIs remain near or in contraction. The broader concern we have for China is that this is not just a cyclical downturn. The downturn in the property sector, high debt levels and poor demographics are structural headwinds that will continue to prevent a quick return to growth.

 

It's also important to note that emerging markets are gearing up for the busiest election calendar in a generation this year. One has to go back 20 years to 2004 to see such a heavy emerging market election calendar. There are 16 elections across emerging markets comprising a third of emerging markets GDP. In the run up to these elections, we are monitoring any loss of fiscal discipline or unexpected policy changes after the elections. Elections in four big emerging markets economies — Indonesia, India, South Africa and Mexico — will be in focus. In addition, several smaller economies where we are invested, such as Pakistan, Sri Lanka and Dominican Republic, also bear watching. 

 

In our portfolios, we are positioned with an overweight in duration because we believe US Treasury yields will be lower under either a soft or hard landing scenario in the US. We still believe that differentiation will play a key role in our ability to generate alpha and we focus our positioning on resilient credits with reasonable valuations. Or, in the case of higher yielding names, we focus on credits with positive idiosyncratic developments that justify the additional risks. We see the best value in higher quality high yielders, such as BB-rated sovereigns. In our view, tight EM corporate valuations do not compensate for liquidity risk and recession risk, so we’ve demanded higher risk premiums for corporates and reduced our corporate exposure overall. We have, however, increased our local rates exposure in several Latin American and Central European countries where central banks still have considerable scope to cut rates. We’ve modestly increased our exposure to high carry emerging market currencies as the Fed hiking cycle, and the strong dollar cycle, draws to a close.

 

With that, I'll say thank you again for your time and continued trust in us to create value for you, our investors, responsibly. Thank you.

 

MFSI Emerging Market Debt Strategy

The views expressed are those of the speaker and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice from the Advisor. No forecasts can be guaranteed. Past performance is no guarantee of future results.

 

Important Risk Considerations:

The strategy may not achieve its objective and/or you could lose money on your investment.

Bond: Investments in debt instruments may decline in value as the result of, or perception of, declines in the credit quality of the issuer, borrower, counterparty, or other entity responsible for payment, underlying collateral, or changes in economic, political, issuer-specific, or other conditions. Certain types of debt instruments can be more sensitive to these factors and therefore more volatile. In addition, debt instruments entail interest rate risk (as interest rates rise, prices usually fall). Therefore, the portfolio's value may decline during rising rates. Portfolios that consist of debt instruments with longer durations are generally more sensitive to a rise in interest rates than those with shorter durations. At times, and particularly during periods of market turmoil, all or a large portion of segments of the market may not have an active trading market. As a result, it may be difficult to value these investments and it may not be possible to sell a particular investment or type of investment at any particular time or at an acceptable price. The price of an instrument trading at a negative interest rate responds to interest rate changes like other debt instruments; however, an instrument purchased at a negative interest rate is expected to produce a negative return if held to maturity.

Emerging Markets: Emerging markets can have less market structure, depth, and regulatory, custodial or operational oversight and greater political, social, geopolitical and economic instability than developed markets.

International: Investments in foreign markets can involve greater risk and volatility than U.S. investments because of adverse market, currency, economic, industry, political, regulatory, geopolitical, or other conditions.

Derivatives: Investments in derivatives can be used to take both long and short positions, be highly volatile, involve leverage (which can magnify losses), and involve risks in addition to the risks of the underlying indicator(s) on which the derivative is based, such as counterparty and liquidity risk.

High Yield: Investments in below investment grade quality debt instruments can be more volatile and have greater risk of default, or already be in default, than higher-quality debt instruments.

 

Please see the applicable prospectus for further information on these and other risk considerations.

 

The portfolio is actively managed, and current holdings may be different.

 

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