Exploring Opportunities in Emerging Markets

Stewart: Welcome to another edition of The Insurance AUM Journal podcast. My name is Stewart Foley and I’ll be your host standing with you at the corner of insurance and asset management with Tom Smith of MetLife Investment Management. Welcome Tom.

Tom: Thank you sir, it’s great to be here.

Stewart: Tom, you’ve been in the emerging markets for a long, long time, and you’re a portfolio manager more than 20 years of it. It’s a very hot topic today, there’s a lot of very good perceptions and some misperceptions out there, rightly or wrongly, many investors look at this as a riskier asset class. Most insurance companies, as we all know, are traditionally conservative investors. What’s the case for investing in emerging market debt?

Tom:  Thank you sir, that’s a great question. And we believe the case is pretty compelling. And the number one headline in your face reason or rationale is income enhancement. As an example, we see Triple B EM corporates, which by the way, get the same capital charge as a Triple B develop market credit at 30 to 40 basis point pick spread versus US corporates at the index level.

Stewart: But that’s at the index level, but you can see individual segments or individual securities that can be substantially different than that, right?

Tom: And we do. For instance, if you look at an emerging market bank versus a US or European bank, we see that spread pickup in excess of that amount oftentimes, comparing utilities in emerging markets versus US credit. Definitely there’s more interesting opportunities out there.

Stewart: The asset class has matured, if you will, become more accepted, deeper, broader. Can you talk about today’s EM versus 20 years ago’s EM?

Tom: 20 years ago, the asset class was brand new and it definitely has consolidated over the past two decades. In fact, just looking at outstanding issuance, the asset class has grown tenfold from 200 billion to over two trillion today. And if you look at just the investment grade portion of outstanding EM debt, it’s equivalent to around 11% of the Barclay’s IG.

Tom: Another thought on that is that the space is so large and broad today that investors who invest in emerging markets, we believe can achieve inherent diversification within the emerging market space. And what do I mean by that? Well, there are lots of opportunities. So roughly half of the space is corporates on a market value basis, the rest is sovereigns and clauses sovereigns obviously. We have the full quality spectrum. It is skewed towards investment grade, it’s around 55, 56% investment grade, and both the corporate and sovereign indices. We have all durations, so an investor that’s looking for a short dated risk can find lots of opportunities in emerging markets and the same thing out the curve, we have bonds all the way to 100 years nowadays.

Tom: And then in the hard currency space, obviously the dollar issuance is the lion’s share, but there is an increasingly prevalent amount of Euro issuance and the secondary liquidity on that has improved substantially. And for the bravest investors, there are some opportunities in the local currency space that can be either hedged or unhedged.

Stewart: You mentioned comparing the spreads in the developed markets versus the emerging markets. The old adage is, is it cheap or cheap for a reason? So can you talk a little bit about the fundamentals, emerging markets versus domestic markets generally?

Tom: Yeah, that’s a great question. And certainly there are some emerging market credits that are cheap for a reason, but generically, we view EM fundamentals favorably relative to the developed markets, and let me give you a few examples. First of all, focusing on corporate investment grade credit. If you look at leverage ratios, this is net leverage pre-COVID, emerging markets IG 1.4 times levered, compare that to the developed market space around 2.5 times. Both have drifted up a little bit with the pandemic, but emerging markets still remains inside of the developed market leverage figure.

Tom: Another point is growth and just the historical and potential growth differential in emerging markets favors emerging markets. So if you look at JPMorgan macro data, we have a lot of respect for their macro team, for 2021, they have potential EM growth ex-China of 3.4% versus 1.4% for the developed markets. And that growth differential is largely driven by favorable demographics or relatively favorable demographics in the emerging markets where the developed markets is still very much plagued by the headwind of older populations. And while emerging markets may be moving in that direction, in some cases, most countries are still quite a few years away.

Stewart: So we talked just a moment ago about the differences in EM 20 years ago versus EM today, it was far less common when MetLife began your exposure that was more than 20 years ago. So how did MetLife get comfortable with EM exposure over the years?

Tom: Great question. In my opinion, MetLife is one of the pioneers. My colleagues and I have been involved in the asset class for 25 years, and we’ve been through many cycles, many ups and downs, we have many lessons learned. And if you think about what it takes to learn how to ride a bicycle and all the times you have to fall down and the battle scars that you get from that, to the extent that battle scars can comfort you, we have some, and certainly that experience has helped us develop conviction over the years in the space.

Tom: But another thing that’s super important, MetLife Insurance Company decided very long ago in their early days, late ’90s, and it wanted to be as close as possible to the issuers. So in the late ’90s, the company proceeded to open up regional offices in all three major EM regions. So Latin America, Asia, CEEMEA. In fact, I was hired in the Buenos Aires Argentina office in 2001 before moving to Chile with the rest of the team in 2003.

Tom: And just one final thought on that, proximity being close to the issuers, it gives you live time zone coverage. Most of us are sleeping while Asia is doing its thing. Nothing’s worse than waking up to some horrible headline that happened eight hours ago. Our analysts are there on the ground and they’re digesting that and speaking to the company and local analysts, et cetera in real-time.

Tom: And another point is if you have a regional presence, you can hire local experts with a cultural linkage, with language skills, they have their own local contact set, and one thing that I find personally very important is the relatively easy striking distance for regional travel. So I always joke with our colleagues in Hong Kong when they’re complaining that they have to fly four or five hours to Delhi or Jakarta, that that’s a lot better than my 14 or 18 hour flight from New York.

Stewart: Absolutely. And I think it’s one of the most impressive things that I didn’t know about what MetLife Investment Management does. I was very impressed with that when I learned it. And one of the things you said early on was that income enhancement is one of the key benefits to the asset class. And as we both know well, insurance companies need investment income now more than ever, particularly given where interest rates are and the general consensus that they aren’t going up anytime soon. So what level of involvement are you seeing insurance companies involved in emerging markets?

Tom: The larger companies are involved, but not all to the same degree. Generally speaking, we have observed that EM exposure in the insurance industry is anywhere between zero and 10% of each company’s total public bond exposure, with the sweet spot being somewhere between three and 4%. And I did say zero, so there are actually many companies that are not involved in the space. And what we run into sometimes is investment teams that have been mandated to go look for ways to create income enhancement opportunities for their firm, and they like the opportunity in emerging markets, but they have a hard time getting approvals from some of the senior members of their investment committee because of strong historical biases that they have.

Tom: And I understand this, I’ve been around for a long time and I’ve seen the headlines and the history, it can be scary. And even recently, headlines about contagion continue to be out there. However, our view is that contagion within the emerging markets fitness is simply not a thing anymore. And the most recent case that we saw of this was in 2018, Turkey was having a currency crisis and I was about ready to throw a stapler at every TV on the trading desk, my colleagues had to hold me back, because every one of them had a big headline saying emerging markets crisis, Turkey crisis contagion, et cetera.

Tom: But the fact is nowadays investors in the space are just way better at differentiating risk than 20 years ago. Why? Because there’s a broad understanding that a currency crisis in Turkey doesn’t affect the fundamentals of Colombia or Indonesia or any other EM country. And I think asset allocators are starting to get that point, but the headlines do keep it on the confusing side.

Stewart: It’s interesting, insurance companies, as you mentioned, except for the very, very largest ones, often don’t have the internal resources. I think that outsourcing EM is very compelling, particularly when you’re talking about the level of infrastructure that you’ve got in place with the regional offices and so on and so forth, you can’t replicate that as a mid smaller insurance company. And that’s the kind of coverage you need to stay on top of the asset class. Now, as everybody knows, this COVID-19 crisis has impacted every corner of the globe. There was substantial market dislocation earlier this year as a result, what was your experience with COVID-19 in emerging markets?

Tom: It was difficult. We thought we were set up for a pretty decent year. The China trade war had come to an end with an agreement in December. We believe that trade tensions were largely behind us for the first year and that we would have generally quiet first half before moving into election mode later in the summer, but COVID happened very quickly. We had been tracking COVID in China from very early on, and we were getting very helpful real-time input from our colleagues in Hong Kong, and MetLife’s Insurance office in Beijing has a lot of people on the ground. And with that information, we had been flagging the risk to our investors.

Tom: So we moved to raise cash and go light on risk by mid February. And we thought that the pandemic would play out in the rest of the world the same way it did in China, so we expected a brief disruption, maybe six to eight weeks, and then back to business as usual. Well, we were wrong. And in many ways this was a repeat of the global financial crisis, it just played out a lot faster.

Tom: This time around the global central banks were definitely better prepared. They brought out the bazooka early and really we got the normalization call. We were willing to deploy cash more heavily early on in April, May, but we were talking about normalization with differentiation. And what I mean by that is going into good credits, which would get back to normal quicker and weaker stories would become more idiosyncratic and lag the rallies.

Tom: And the trick really Stewart, was how to differentiate. And what we did was we added some enhancement to our existing sovereign credit research process, which already is robust. We have eight sovereign credit research analysts located all over the world, but what we asked them to focus on during the pandemic was resilience. We wanted to know which countries would make it through the cycle without losing their NEIC rating and without having any funding distressed. And as we did that, we basically had three buckets and one of them was resilient, one of them was troubled and the other one was an unfolding bucket. And we were able to go in and buy those resilient credits and some of the unfolding ones that we liked better that we thought offered better value and move aggressively into those credits early on.

Stewart: As is often the case. So market dislocation can create good opportunities if done well. What about EM corporates, how have they done in the pandemic based on your experience?

Tom: I’m glad you asked about corporates because corporates are an increasingly important part of our space and we see a really good alpha opportunity in the corporate space, especially for insurance companies. So to answer your question, corporates have done much better across the board than the sovereigns. And really, it’s about the starting point. There is less leverage, as I mentioned before, versus the developed market space that came in clean balance sheets. They had already been doing quite a bit of liability management in 2019, and that has continued in 2020 opportunistically.

Tom: I’ll also mention that it wasn’t across the board, there were some corporates that faced more challenges, and those were generally in the travel and retail sectors. And then it was corporates also located in those countries with bigger sovereign concerns like South Africa, Turkey and Argentina.

Tom: Let me provide a couple of stats on the corporate space, because I think it’s interesting for those that are listening. When you look at fallen angels, which is a big deal for insurance companies that have to rewrite their capital charges for credits that they thought were investment grade. Fallen angels year-to-date in the EM investment grade space has been 9.4%, very comparable to the 10% you’ve seen in the US corporate space. But one big credit that affected both the US corporate and emerging markets basis, Pemex, Petróleos Mexicanos, the Mexican oil company.

Tom:  And if you net out Pemex and look at what’s left, the emerging market space, ex Pemex had fallen angels at 2.8%, whereas the US corporate space had fallen angels at 7%. And I wanted to throw out just one more data point, defaults. A lot of people ask about defaults. We try to avoid defaults as much as we can with our insurance clients and move out of credits that we think are going to have any kind of credit issue at all early, but it is worth noting. EM high yield defaults 3.1% on a trailing 12 months through October versus 6.5% for US corporate high yield. So again, pretty good comparable figures there.

Stewart: You’re tossing out insurance specific issues related to capital charges and so on and so forth. You’re knee deep in managing money for insurance companies, and it just comes naturally to you. But the fact that you’re considering those capital charges and regulatory treatment is something that’s worth pointing out. So managing money for insurance companies is different than managing money for other institutions, and it matters. You mentioned that EM is doing well in prior cycles, what can you tell us about that?

Tom: MetLife has been involved in emerging markets since 1996, and since then there have been a lot of global macro cycles and idiosyncratic country events that the emerging market space has had to weather. And what we know for a fact is the EM space is not immune to global down cycles. Correlations remain high across asset classes and especially in a macro event.

Tom: We actually went back in a recent white paper that we did and looked at 12 big events over the past 24 years and studied them just to see how emerging markets did through those cycles. This goes all the way back to the Asia crisis of 1997. In 1998, we had Russia LTCM, in 2000, the.com bust, 2001, 9/11, in 2002, there was a Brazil specific crisis that was problematic for EM more broadly, then we had a nice quiet period from 2003 until 2007 before we got whacked by the global financial crisis in 2008, 2009, which seemed to just stretch right into the European sovereign debt crisis of 2010 through 2012.

Tom: And then when we thought all that was over, we got the taper tantrum of 2013. If you’ll remember The Fragile Five, couple years after that, the commodity downturn of 2015 and 16. 2017 was a great year, no issues, we always referred to it as hakuna matata. There was no worries for the rest of your days. But then the trade war came in 2018, 2019 with several risk on, risk off events during that period, before we got the mother of all exclamation points with the global pandemic of COVID 2020.

Tom: And after going through this list, in the study that we did, what we observed is that EM always follow the developed markets into downturns and often underperforms at the worst of a crisis, but it also tends to come back and even outperform over the entire cycle. So our opinion is that investors that invest through the cycle have historically been rewarded.

Stewart: I was a portfolio manager as well, so this one’s near and dear to me. As a portfolio manager, is there anything you can do to prepare for these cycles? And oh, by the way, just for whatever it’s worth, as you read those events, I got chills. I’m like, “Oh yeah, I remember that one.” So how do you prepare for it?

Tom: Well, we have a total return mindset in all market environments. We think this is critical to idea generation and adding alpha to our investor portfolios. And so, whether it’s carry, or spread compression, or affects movements, our aim is to create economic value for investors in accordance with their objectives and consistent with their constraints.

Tom: So in normal times for yield starved insurance investors, that means buying good quality EM assets that provide some diversification and are attractive for their current rating and rating trajectory. And we’re always careful to buy assets that are appropriate for their risk tolerance and mindful of capital charges.

Tom: So that’s my preface, but you asked me about cycles, how to apply a total return approach and a down cycle. Well, the first point I would make is that you have to accept that the cycles occur, I went through the laundry list and you have to be willing to hold through the cycle, but security selection is key and it’s key in any market. We are constantly adjusting positions based on our fundamental credit base. But when you go into a macro event, some credits are going to be more vulnerable to that event. So you have to be willing to reposition and reposition early when the risk of a macro event seems elevated, and that might mean generically, just going up in quality within the emerging market space.

Tom: One final point I want to bring up that I think has benefited a lot of investors over time is the willingness to actually buy the down cycle. And insurance companies are in a very unique and special position, they don’t face outflows like institutional investors, they have sticky money and we even had several clients that bought in the April, May period, sent us new money, and one client was even a brand new EM mandate that funded, and congratulations and kudos to them, some bonds of defensive IG issuers, roundtrip 30 to 40 points over that period.

Stewart: It’s remarkable, it’s just remarkable. It’s been an eventful year, 2021 is right around the corner. How do you see it shaping up for the EM fixed income space?

Tom: Well, good to have the horrible COVID 2020 behind us, hopefully. In our view, vaccine plus Biden and the Republicans is a good backdrop for EM. We think we’ll get a gradual growth recovery that should allow EM countries to shore up their financial situation, but we’re not expecting a sharp enough and robust enough global growth momentum to really merit any kind of withdrawal of liquidity that can pose other problems for EM. Would you expect yields to move higher? With 10 year US real rates less than negative 70 basis points, that just seems unsustainable in an environment that’s returning to normal. Breakevens seem reasonably priced, so you potentially see 50 to 75 wider and global rates at least US treasuries.

Tom: So based on our view of EM valuations, we think we could see some spread compression in the IG EM space, probably limited, and I think insurance investors would probably welcome higher yields in those assets. Stewart, it’s never a dull year in the emerging markets and we do expect it to be busy once again. So if we drill down into what we expect specifically in emerging markets, first, I’ll start with sovereigns. Sovereigns have been hit very hard. Every country in the world, whether emerging or developed, faced a huge growth contraction and immense fiscal needs. So all of that points to one direction, which is higher debt.

Tom: So a lot of EM countries, we do expect to stabilize during 2021, but others we expect have work to do beyond 2021. So we’re still thinking resiliency there. And just as an example, a couple of countries come to mind, Colombia and Brazil, both need fiscal reform to avoid downgrades next year.

Stewart: So when you look out at 2021, and you mentioned drilling down, what’s the winners and losers list by country? Do you see a differential in terms of economic recovery and growth?

Tom: Yeah, we could do a whole podcast just on that question, but I will say that Asia is an outperformer and a lot of it is around China. Actually, I’m going to amend what I said before, China was actually the only country in the world not to contract this year, at least that’s what we’re projecting. And we do project an 8% growth rate next year. This is going to help boost the rest of Asia. So we’re seeing Indonesia, Malaysia, Vietnam, Korea, and others that are really going to benefit from that regional boost.

Tom: I want to bring something else up. We always look at elections in the emerging market space when we do a look forward. The elections in 2021 are mostly in below investment grade countries and places we aren’t really involved in for insurance accounts. It’s places like Ecuador, El Salvador, Zambia, but I think it is really important to mention with this crowd, Peru and Mexico, they both have important elections coming up next year. In April, we have the Peru general elections, and then later over the summer, legislative elections in Mexico. So we’ll be watching those very closely.

Stewart: Well, it’s been my pleasure to have you on. I just have my one favorite going out the door question. You went to Southwestern and Texas-

Tom: Yes sir.

Stewart: … let’s call it maybe a year ago. My students and others had lots of opportunities. Some of them had multiple job offers, had multiple internship offers and all of that dried up like liquidity did earlier in the year. So you are walking across the stage and you get handed a diploma by the president of Southwestern. As you come off the stage, you today, Tom Smith, meet 21-year-old Tom Smith, what do you tell your 21-year-old self given where we are in this environment?

Tom: Have fun, enjoy being young, anyway, besides all that stuff.

Stewart: Realize that now you have zero worries in your entire life, even though you think you do.

Tom: Zero back pain, no creaking knee, things like that.

Stewart: Exactly.

Tom: First of all, I would consider myself a late bloomer. So if you didn’t do great in school and you don’t have a clear path ahead of you right now, you aren’t alone. I always joke with people, my passion in school was baseball. I played baseball at the collegiate level and I spent a lot of time in Latin America, actually in Dominican Republic, I went to Cuba to play baseball during those years and it was a great time for me, but I joke with my friends that I was four A’s away from being an Academic All-American.

Stewart: That’s great.

Tom: So for those of you who have a great job lined up, then go work hard, learn all you can and enjoy it. And if not, hang in there, keep looking, find new ways to differentiate yourself. For me, that meant going to Latin America and getting in the back door. I was passionate about baseball, but I was also passionate about Spanish and double majored in Spanish and International Studies, and that helped me get in the back door, and I actually took a job for MetLife in the regional office way back then.

Tom:  So the last thing I’ll say is I realized that I haven’t had to look for a long time thankfully, but finding a job is a full-time job. So stay active, keep learning, stay on top of market views, et cetera. And the last thing I’ll leave you with is, enjoy reading. These days I’m so snowed over with work that I only have time for maybe 10 to 20% of what I intend to read. So read everything you can and enjoy it because it won’t always be that way.

Stewart: That’s great advice. Listen man, thanks for being on, we had a great time and I learned, every time I do a podcast, I’m really fortunate, I get to learn from people who are at the very top of their fields. And so again, this time, I think the person who probably learns the most on these deals is me. So thanks for being on.

Tom: Thanks for the invite.

Stewart: Of course, we appreciate you. And just real quick, a couple of housekeeping notes. There was a recent press release, we are entering into a joint venture with CAMRADATA, and our goal is to bring a manager, evaluation and search tools to insurers, which will be free of charge, more to come. We’d love to hear your ideas for future podcasts. You can reach us at podcast@insuranceaum.com. If you like what we’re doing, tell your friends, share our LinkedIn posts and follow us on all the major platforms. Thanks for listening. I’m Stewart Foley, and this is The Insurance AUM Journal podcast.


This article has been prepared in conjunction with MetLife Investment Management (“MIM”)1 solely for informational purposes and does not constitute a recommendation regarding any investments or the provision of any investment advice, or constitute or form part of any advertisement of, offer for sale or subscription of, solicitation or invitation of any offer or recommendation to purchase or subscribe for any investments or investment advisory services. The views expressed herein do not necessarily reflect, nor are they necessarily consistent with, the views held by, or the forecasts utilized by, the entities within the MetLife enterprise that provide insurance products, annuities and employee benefit programs. Subsequent developments may materially affect the information contained in this article. Affiliates of MIM may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives) of any company mentioned herein. This article may contain forward-looking statements, as well as predictions, projections and forecasts of the economy or economic trends of the markets, which are not necessarily indicative of the future. Any or all forward-looking statements may turn out to be wrong. All investments involve risks including the potential for loss of principle.

1 MIM is MetLife, Inc.’s (“MetLife”) institutional management business and the marketing name for subsidiaries of MetLife that provide investment management services to MetLife’s general account, separate accounts and/or unaffiliated/third party investors, including: Metropolitan Life Insurance Company, MetLife Investment Management, LLC, MetLife Investment Management Limited, MetLife Investments Limited, MetLife Investments Asia Limited, MetLife Latin America Asesorias e Inversiones Limitada, MetLife Asset Management Corp. (Japan), and MIM I LLC.

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