IA Clarington Emerging Markets Bond Fund
Manager commentary - December 31, 2018
Emerging market (EM) performance was mixed in the fourth quarter of 2018 as geopolitical risks, an uncertain macroeconomic outlook and an easing of external challenges exerted counterbalance that helped EM debt exhibit resilience amidst rising volatility across developed market (DM) asset classes. The ongoing trade dispute between the U.S. and China showed no signs of abating in October, and EM sentiment was further challenged during the month by relatively robust economic data from the U.S., which supported an increase in both the U.S. dollar and Treasury yields. Despite the macroeconomic challenges that weighed on EM in October, country specific trends appeared to be improving, highlighted by rate hikes and currency stability in Turkey and Argentina and the victory of Jair Bolsonaro, the most market friendly candidate, in Brazil’s presidential election.
Trade tensions between the U.S. and China continued to challenge investor confidence in November. However, EM sentiment did benefit from a softening U.S. economic outlook, which resulted in a decline of the dollar and Treasury yields, both of which are supportive for EM. Focus on the economic outlooks for both the U.S. and China remained top of mind in December. Progress toward a trade resolution between the world’s two largest economies was positive for the global outlook; however, both face economic uncertainty. In the U.S., the relatively hawkish stance from the U.S. Federal Reserve (Fed) increased concern that monetary policy could constrain U.S. growth and lead to recession. Concerns in China, while relevant for EM and the global economy, were somewhat less severe, as investors sought clarity regarding the extent to which policymakers can counteract a secular slowdown driven in large part by economic deleveraging and the impacts of U.S. trade restrictions. Declining expectations for global growth and high stockpiles weighed on oil prices throughout the quarter; however, OPEC production cuts announced in December are expected to stabilize oil prices in a range that is positive for EM economies in aggregate. Aside from China, developments across EM were largely benign during the quarter, as most economies exhibited relatively supportive trends.
For the quarter, the Fund underperformed the benchmark due primarily to negative contributions from asset allocation and decisions within each allocation. The Fund’s underweight in local currency debt detracted from performance as local currency outperformed, recovering from a sell-off that spanned much of the second and third quarters. Decisions within the local currency debt allocation detracted from performance, as negative contributions from underweight positions in Turkish lira and South African rand, as well as an overweight position in Colombian peso, overshadowed positive contributions from overweight positions in Brazilian real and Argentine peso. Security selection within local Mexico, Brazil and Argentina also detracted from performance. Within the external debt allocation, country selections among external sovereign debt detracted from performance, as negative contributions from overweight positions in Argentina, Oman, Sri Lanka, Mexico and Senegal and underweight positions in Brazil and China overshadowed positive contributions from underweight positions in Ukraine and Venezuela and an overweight position in Qatar. Within the corporate debt allocation, overweight positions in Kazakhstan and Mexico, along with security selection in Turkey, detracted from performance.
It was a challenging year for EM debt. However, in our view, much of the year’s volatility had more to do with technical factors associated with risk aversion stemming from a few highly visible, idiosyncratic risk events than fundamental weakness across EM. China remains a concern, as deleveraging and domestic vulnerabilities, along with uncertainty regarding a trade war with the U.S., have fueled pessimism regarding China’s economy. Recent developments between the U.S. and China suggest that a de-escalation of trade tensions is possible, which could support some upward revisions to consensus estimates for China’s economic growth in 2019. China is not the sole factor driving expectations for a deceleration of global growth next year, as the U.S. economy appears poised to slow as the effects of fiscal stimulus run their course. The market’s initial reaction to Jerome Powell’s hawkish post-Federal Open Market Committee (FOMC) press conference reflected an uneasy outlook, as volatility surged across U.S. capital markets. However, that volatility has seemingly influenced softer rhetoric from the Fed Chair over the past few weeks and the December FOMC minutes revealed that tighter financial conditions have already caused several FOMC members to lower growth forecasts. Uncertainty regarding both the U.S. economy and monetary policy remains; however, the changing perception of the Fed suggests a possible policy shift in the face of a moderate growth slowdown, either through a pause in rate hikes or an end to balance sheet reduction. Such an outcome would be supportive of risk assets globally, and EM debt would likely benefit. EM currencies in particular would be attractive in such a scenario, as we would expect a gradual decline of the U.S. dollar and for EM currencies to be supported by not only faster economic growth and improving account balances, but greater demand driven by attractive carry.
While markets are likely to remain focused on key macroeconomic risks early in 2019, idiosyncratic risks will likely ebb and flow, highlighted by vulnerabilities in Turkey and Argentina and uncertainty surrounding the policy agendas of new governing regimes in Mexico and Brazil. Emerging markets remain sensitive to capital outflows, but better fundamentals, such as smaller current account deficits, more manageable near-term debt maturities and more favorable economic outlooks, make most emerging markets less vulnerable to outflows and lessen the chance of a major sell-off like in 2013. Market volatility has caused valuations to cheapen substantially, and while that may provide a buying opportunity, external factors and a slowdown in global growth could still cause bouts of volatility and challenge investor confidence. Ultimately, the longer-term fundamental backdrop for emerging markets remains positive and we expect that the improved relative value considerations should once again provide EM debt with the technical support of robust demand.
|Fund and benchmark performance as at December 31, 2018||1 year||Since inception|
|IA Clarington Emerging Markets Bond Fund – Series A||-7.0%||-5.5%|
33.3% J.P. Morgan CEMBI Broad Diversified Index, 33.3% J.P. Morgan
Learn more about IA Clarington Emerging Markets Bond Fund
The performance data comparison presented is intended to illustrate the Fund’s historical performance as compared with historical performance of widely quoted market indices. There are various important differences that may exist between the Fund and the stated indices that may affect the performance of each. The benchmark is a blend of J.P. Morgan CEMBI Broad Diversified Index (33.3%), J.P. Morgan GBI-EM Global Diversified Index (33.3%) and J.P. Morgan EMBI Global Diversified Index (33.3%). The blended benchmark presented is intended to provide a more realistic representation of the general asset classes in which the Fund invests. The J.P. Morgan CEMBI Broad Diversified Index is composed of U.S. dollar-denominated, emerging market corporate bonds. The J.P. Morgan GBI-EM Global Diversified Index is composed of local currency bonds issued by emerging market governments. The J.P. Morgan EMBI Global Diversified Index is composed of hard currency bonds issued by emerging market governments. The Fund’s market capitalization, geographic, sector and credit quality exposure may differ from that of the benchmark. The Fund’s currency risk exposure may be different than that of the benchmark. The Fund may hold cash while the benchmark does not. Overall, the Fund's bond and equity exposure can differ, because the Fund does not use a fixed ratio similar to the benchmark. It is not possible to invest directly in market indices. The performance comparison is for illustrative purposes only and does not imply future performance.