Samy Muaddi, lead manager of T. Rowe Price’s emerging markets corporate bond strategy, speaks with Global Finance about managing risks in emerging markets.
Global Finance: Emerging markets are often associated with higher risk. How do you view risk in emerging markets, and how do you avoid trouble?
Samy Muaddi: In the pursuit of short-term profits, investors will make tragic mistakes. There are effectively four aspects of emerging markets analysis that you need to solve for. If you can solve for those things, you can avoid the scams and country blowups.
The most common one would be a fiscal crisis: traditionally, overspending by governments themselves. Generally speaking, emerging market countries have learned this lesson. Emerging market debt to GDP peaked in the 1990s and is now, on average, around 45%. The second issue is politics. I would focus on institutions, not individual leaders. How independent is the central bank? How free is the media? The third is external factors. There are countries that need foreign capital to mobilize growth. This can be ruinous for countries if mismanaged. The fourth factor is contingent liabilities. These are things that aren’t fiscal issues today, but will potentially be fiscal or growth issues tomorrow. It’s a dynamic model. I think it’s a better model than using credit ratings, which are a very linear scorecard for trying to capture a nonlinear risk profile.
GF: What are your feelings on negative interest rates and their role in attracting investors to emerging markets?
Muaddi: Negative yields are one of the best things that have happened to our industry. I would struggle to find another asset class that can do 7% a year, given that the S&P is at 3000. US equities have traditionally been the most efficient source of capital return, along with US high-yield bonds, but yield is lacking. I would encourage investors to get in the door. If you can find the 6% interest rate, just take it while you can get it.
With negative interest rates, we are experimenting with something that may have dire consequences. Think about a European bank today; in Denmark now, you can even get negative-rate mortgages. I think economies largely grow because of the credit multiplier. If banks aren’t incentivized to lend, that crushes your credit multiplier. So unless productivity is going through the roof, or governments are going to print deficits to keep the fiscal expansion as an offset, you’re going to have just muddled growth and lack the ability to save at a risk-free rate. And I think there are social consequences to that.
GF: Which countries are most at risk of a sovereign crisis?
Muaddi: Within emerging markets, I think the next crisis candidates, in order of likelihood of outcome, would be Zambia, Lebanon and Turkey. I was overweight Turkey after August 2018 because of its fiscal anchor, but we’re witnessing a deterioration there. That is deeply concerning. When the next shock comes, I feel it won’t have the ability to recover as easily as it did in 2018.
GF: Which sectors are you eyeing?
Muaddi: We tend to find that [small and midsize enterprises] are poor capital allocators and have lower yields because there’s a perception of implied support from the government. We have a bias toward private companies as more efficient capital allocators. We tend to be overweight the consumer, whether it be real estate, telecommunications or traditional consumer goods. That’s just a more durable source of earnings in an environment of uncertainty from a global trade perspective. I want to reduce some of the cyclicality in growth. We’re underweight energy; that’s more of a bearish house view on long-term energy prices. Generally, I’ve never been overweight financials in my career, so that’s usually my largest underweight.
