Stewart: Welcome to another edition of the insuranceaum.com podcast. We are very happy to have Tom Smith back from MetLife Investment Management. Tom is a repeat guest on the show. You're here to talk about emerging market debt again. Man, Tom, welcome. Welcome back.
Tom: Hey Stew, thanks for having me back. It's been a while. Good to see you.
Stewart: Yeah, I think we had some kind of technical problem the last time we did this and I think I screwed up the recording, so I'm going to try and do a better job here this time. Before we get started too far, I don't think we covered this last time you were on, so can you give us your hometown, first job, and a fun fact.
Tom: Hometown, first job, fun fact. Hometown, Dallas, Texas. That's where I was born and raised. First job was ... Lots of first jobs, actually. But probably the most notable was landscaping, maintenance guy, weeding, mowing lawns, et cetera.
Stewart: It gets hot in the summer in Dallas too.
Tom: It gets very hot.
Stewart: Very hot.
Tom: Now that I live in New Jersey, I always tell people that you're not allowed to complain twice a year. You can complain about the heat or you complain about the cold, so I pick the cold.
Stewart: But not both. There you go.
Tom: Not both. What was the third question?
Stewart: Fun fact. Fun hobby. Fun. Fun.
Tom: Fun fact.
Stewart: Yeah.
Tom: Fun fact about myself. I've spent, gosh, the last 20 years traveling throughout the world. Lived in Latin America for 15 years. Loved that, and been to 60+ countries.
Stewart: Oh, that is a fun fact. That's very cool. I bet there's some interesting countries in that list as well. So you are an emerging market portfolio manager at MetLife Investment Management. We were kidding on the call just a moment ago, that makes you an EM PM, and the last time you were on it was fantastic, so I want to start out kind of just in a broad brush way here. So closing out 2022 and heading into 2023, there's been no shortage of volatility, concerns about inflation, prospects for inflation in many markets, what the Fed is going to do, on and on and on. So what is your broad outlook for emerging market debt with so much influx?
Tom: Yeah, that's a very broad question and I'm going to give you the economist answer. It depends. It depends a lot on the macro environment, right? The macro environment was a huge determinant of risk for the emerging markets in 2022. It's still crucial as we roll through 2023. So if I'm going to formulate 2023, I have to bridge it with what the key 2022 macro drivers were. There's not going to be any surprises here for your audience and I don't want to bore anyone with excruciating details, but I do think it's super important to talk about the unanticipated macro shocks that we faced in 2022. Obviously, they were in Ukraine, global inflation, which was higher and broader than anyone expected it to be, and China's zero COVID policy, which essentially removed a key growth engine from the global economy.
And all three of those factors are now showing signs of reducing pressure on the markets and in rank order to just go through those, I think the best news is coming from China where zero COVID policy has been effectively torn down in December. And with that, Stewart, do I dare say the pandemic is officially behind us? Hopefully. So some of the key stats there, most of the population in China has been exposed in the past two months. The official data show that the peak in infections was in December and the peak of hospitalizations was earlier this month in January.1 So if all that holds, we would expect a really nice growth rebound to take hold immediately. There's a lot of pent-up demand and so we would expect growth to last probably throughout the year.
Then comes inflation, the second big 2022 driver. Now we've had three soft inflation prints in a row in the U.S. By the time your listeners hear this, we're going to have a fourth. Hopefully, it's a fourth soft inflation print. But with that both U.S. and global inflation appear to have peaked, including in emerging market countries. So on the margin, we are feeling better. Let's call it cautiously optimistic on the inflation trend.
The third big theme, obviously, was the war in Ukraine, which is ongoing, but for a confluence of reasons we're not really seeing the ongoing effects in the markets specifically in food and energy prices that we did in the first half of last year. So if this macro environment holds, Stewart, it will be supportive for emerging market debt.
Stewart: And that's the macro side of things. Can you talk a little bit about the bottom-up nature of emerging market debt?
Tom: Of course. Yeah, and that is where we spend the vast majority of our time, it is in transitional moments like this when we do have to spend an inordinate amount of time thinking about the macro drivers. But right now as it relates to the bottom-up fundamental view of corporates and sovereigns, I'll keep this brief and at your option, we can dive into either of these later. And let's start with the best news, corporate fundamentals and emerging markets, very solid. In fact, perhaps the best ever, whether we're looking at operating statistics or balance sheets, EM, corporates are in a really good spot. Sovereigns, which are still somewhat scarred by the pandemic, they started making a comeback in late 2021, early 2022, and then they got hit by this macro tornado that I described before. And so now heading into 2023, if we do have this more positive macro outlook holding, a few things may happen that I think are relevant.
First, issuers, both corporates and sovereigns, will likely have much easier access to the markets in 2023 than they did in 2022. Another factor is commodity prices, and with a better macro outlook, we would expect commodity price stability, which is really good for everyone. A lot of people think of emerging markets as commodity rich and that's true, but it's actually a pretty balanced mix of commodity importers and exporters. And if you look at oil prices as a gauge, $70 to $80 where we currently are, that we believe it's a sweet spot. It's not too high for oil-importing countries, but it's also a level where oil exporters are making good money.
Stewart: That's helpful. I mean you've done this for a long time and you've lived a lot of places, as you mentioned at the top of the show. What does history tell us about buying opportunities in EMD right now?
Tom: Yeah, EM typically has a higher beta response to global events, Stewart, and we certainly saw that in 2022, but emerging markets is really no stranger to shocks. We've been through quite a few cycles and we are convinced that emerging markets is worth holding through the cycle. Just to share some historic data that we've compiled, we looked at the last 20 years of returns data and EM tends to outperform developed markets in both excess return and risk-adjusted return through different market environments. We looked at five specific historical periods, and I won't go through all of them, but just for example, the developed market crisis of 2008, 2012, the taper tantrum and commodity bust of 2013 to 2016. And of course, today's environment is COVID and its aftereffects, which began in 2020, and is still ongoing.
And in all of the historic cases, except for the one we're currently in, emerging market investment grade outperformed U.S. IG credit, again, on both total excess return and risk-adjusted return basis. The high yield elements of the market, high yield EM over U.S. EM, those results are a little bit more mixed, but still favorable to EM, relative to DM. And one final note, the current period, as I mentioned before, started in 2020, it's ongoing. We believe Emerging markets is underperforming, but that's kind of what you'd expect at this point in the cycle, right? We believe The cycle isn't complete yet and really it's not until we get to the other side that we would expect for emerging markets to rally and catch up.
Stewart: Whenever I'm interviewing somebody who's an asset class specialist PM, I try to put on my CIO hat, right? So I'm going to put my CIO hat on right now and say how should I be thinking about domestic markets versus emerging markets? In particular, given so many unknowns across the globe, what role can EM play for institutional investors but more specifically for insurance investors, which is our entire audience?
Tom: Yeah, that's a great question and I'm a little bit biased. I've been in EM PM for over a decade now and I've worked in the asset class for almost 25 years, and in my experience, we've been able to find value in emerging markets assets within the asset class in all different macro environments. And I think the same is true for asset allocators and crossover investors as well. In EM, you're picking the additional spread for the same rating and same capital charge, and really in most cases.
And fortunately, all the insurance investors that we work with understand this dynamic and they're willing to take longer-term views and ride out the hard times like 2022. In fact, several of our investors allocated new funds to the EM fixed income space during 2022, and looking back on that, it was hard to get the timing just right on rates because it was so volatile in the rate space. But those who've added since the middle of 2022, were able to lock in really nice longer-term yields with attractive spreads.
Stewart: That's helpful. So let's talk specifically about EM sovereign debt. What trends are you seeing there?
Tom: Sure. As I mentioned before, we all want to forget about the pandemic, put it behind us, but unfortunately, we can't ignore the lasting effects on global sovereigns and EM sovereigns in particular, just as a general trend, we're seeing them stabilize at a worse level than 2019. What does that mean? I mean, it's higher debt for virtually all sovereigns, and to be a little bit more specific, we've seen roughly 3/4 of all the sovereigns in the EM space with a pretty notable increase in sovereign debt to GDP. That is the key leverage metric that we look at.
If you take an average of all the sovereigns that did undergo an increase, it's about 15 percentage points, which is ... That's pretty meaningful. That's almost an entire rating class, if you ask the rating agencies. And with that higher debt comes an overall weaker credit profile, right? We've seen ratings downgrades much more prevalent since 2019, only a few upgrades or positive outlooks here and there since then. So really it's a story of stabilization where we are seeing a better outlook now three years on.
And let me just say a little bit more about that. For most countries in the EM space, 2/3 based on our calculation, the key leverage ratios that I mentioned before, the delta of GDP and a few others are stabilizing or even declining, but they're not likely to revert back to their pre-COVID levels anytime soon, right? So stable but not necessarily reverting. And then the other 1/3 of the sovereigns in our space, well they still have some work to do. They need to rebalance their fiscal accounts because if they don't, there are going to be concerns about ratings pressure and other consequences.
So the good news here is that there we have very few concerns about countries falling to the next NAIC rating bucket, and I am talking about the older rating buckets, down from the old school NAIC 2 to NAIC 3, or NAIC 1 to NAIC 2. We do expect some degree of ratings migration within, say, the triple B bucket, but again, not really expecting any countries to fall the next bucket.
Stewart: Tom, that's awesome. What about sovereign defaults? What have you seen there?
Tom: Yeah, I'm glad you're asking about sovereign defaults because there have been some headlines around that and we get questions pretty often. Currently, there are 8 EM sovereigns in default. 3 of these were legacy, call it pre-2022, and then in 2022 we had 5 new defaults. 3 of them were related to the Russian invasion of Ukraine, and then two others happened later in the year, Sri Lanka and Ghana. So the key question is could we see more? And once again, I'm going to say that depends on the macro environment, right?
I think if we describe a world where we have some combination of persistent inflation, higher rates, volatile commodities, perhaps all of that leading to a hard landing and global economies across the world are weak or no market access, I think all of those are factors that could lead more countries to default. And the good news here, especially for insurance investors is that the countries that are at risk of default tend to be smaller, single B and lower names. At least for the accounts that we manage for, we deem these countries not to be appropriate for insurance investors because we know that and our insurance investors put a high priority on capital preservation.
Stewart: Yeah, absolutely. And just shifting to EM corporates, and one of the things we had on another podcast, a guest mentioned that EM corporates, that market’s larger than U.S. high yield, which I was really taken aback by. What's your outlook here on EM corporates?
Tom: Yeah, well I was going to say it's a big world out there, Stewart. I mean, you're talking about 70+ EM countries versus one United States.
Stewart: It just shows you, man. I mean, I am the one who gets to learn the most on these podcasts. I'm telling you, I'm getting educated by really smart people like you. So this is ... It's very helpful for me. It makes me sound a lot smarter than I am when I talk to people off these podcasts. So with regard to EM corporates, what are you seeing there?
Tom: Yeah, I mentioned this before, I believe EM corporates are fundamentally in really great shape. I think I mentioned before. And whether you're looking at operating performance, record high revenues, record-high margins, very strong, free cash flow, leverage metrics, the debt EBITDA ratios, lower than previous cycles, EBITDA to interest higher than previous cycles. So looking very robust, and this is not only in absolute terms but also relative to developed market corporates. And I think your listeners will find this interesting and maybe they wouldn't have expected it, but BBB and BB EM corporates have about one turn less leverage versus the exact same rating U.S. peers. So all of this essentially translates into an EM corporate sector that is very well positioned if we do have some kind of slowdown or additional volatility like we had in 2022.
Stewart: I'm glad you brought that up because when I was reading your white paper, I saw that stat and I found it really interesting. So just kind of as we kind of move toward the end here, put my CIO hat back on. Are there any headwinds or opportunities for EM that you want to point out or highlight? For me as a CIO, I'm clearly looking for yield, right? I'm looking for solid risk-adjusted returns. I'm looking for opportunities. Do you see headwinds or what opportunities do you see in this asset class?
Tom: Well, at the risk of sounding like a broken record on your show, I'm going to reiterate, I think the macro environment is critical here. Good news on the macro front means that EM can continue its normalization trend post the pandemic, and you will likely to see rating stability and spreads compress against U.S. IG. So you should see a pretty good economic improvement in EM assets. On the other hand, bad news on the macro front would lead to underperformance of EM assets and we would view this as a buying opportunity. We do that with a keen eye on credit differentiation. We're going to prefer the more resilient credits, sovereigns, corporates, that stabilize from the pandemic that have rating stability, but we're going to buy others as well where we see valuations appropriately compensate investors for the risks that they're taking.
Stewart: Very cool. I appreciate you being on. I always learn a lot from you. You've been in this asset class, as you mentioned, 25 years. MetLife has been a player in this space for a long, long time, and it's always good to get your viewpoint. I have one last question. It's a fun one. A fun question. This is my new one for 2023, Tom, so this is ... Hang on. Hang on to your hat. Hang on a second. Who would you like to have lunch with ... Most like to have lunch with, alive or dead? Any thoughts on that one?
Tom: Yeah, that's easy actually. It's not easy. Can I give you three?
Stewart: Yeah, for sure. You could have a lunch at a table of four. It's you and three other people. Who would they be?
Tom: Oh, that's great. Can it be a golf round?
Stewart: Absolutely. Absolutely.
Tom: No, no. We'll go with lunch table for three, and I'm going to say Jackie Robinson.
Stewart: Oh, wow. There you go.
Tom: Martin Luther King.
Stewart: Wow.
Tom: And Mahatma Gandhi.
Stewart: Wow, that's cool. Who gets to pick the restaurant, right?
Tom: Yeah, I think we'll go Mexican, if that's okay.
Stewart: I like it.
Tom: Tex Mex.
Stewart: I like it. Tex Mex. That's a great table. Well done. We've been joined today by Tom Smith, emerging market portfolio manager at MetLife Investment Management. Tom, thanks for being on.
Tom: Thanks, Stewart.
Stewart: Thanks for listening. Please rate us, like us, and review us on Apple Podcast. We appreciate it. Thanks for listening. My name is Stewart Foley and this is the insuranceaum.com podcast.
L0223029649[exp0225][All States] L0223029681[exp0225][All States] L0223029651[exp0225][All States] L0223029481[exp0225][All States] L0223029630[exp0225][All States]
The InsuranceAUM.com podcast is available on
