As Emerging Market (EM) economies have developed over the past two decades, so too has the opportunity set for fixed income investors. Today, investors considering Emerging Markets fixed income exposure have an even broader spectrum of investment choices available to them than ever before. However, this also presents a relatively new challenge: how to choose which EM asset class to invest in, and in what proportion? Given the importance of the global macro and idiosyncratic themes driving overall EM performance, as well as their impact on individual assets, it has never been more important to have the ability to capitalize on themes and to express investment views in a flexible manner, across the entire investment universe. Here we discuss a potential solution to this challenge; an actively-managed investment strategy which targets a broad universe that includes both foreign (U.S. dollar) and local currency fixed income assets, whether sovereign or corporate. is strategy may provide a solution for investors that want to have exposure to global Emerging Markets, but do not want to conduct their own asset allocation decisions. Investment Focus Emerging Markets Fixed Income: The Case for an Opportunistic Investment Approach CONTRIBUTORS ERIC BAURMEISTER Managing Director Morgan Stanley Investment Management JENS NYSTEDT Managing Director Morgan Stanley Investment Management WARREN MAR Managing Director Morgan Stanley Investment Management JUSTIN MILLER Senior Associate Morgan Stanley Investment Management NOVEMBER 2015 INVESTMENT MANAGEMENT
Transcript
As Emerging Market (EM) economies have developed over the past two decades, so too has the opportunity set for fixed income investors. Today, investors considering Emerging Markets fixed income exposure have an even broader spectrum of investment choices available to them than ever before. However, this also presents a relatively new challenge: how to choose which EM asset class to invest in, and in what proportion? Given the importance of the global macro and idiosyncratic themes driving overall EM performance, as well as their impact on individual assets, it has never been more important to have the ability to capitalize on themes and to express investment views in a flexible manner, across the entire investment universe.
Here we discuss a potential solution to this challenge; an actively-managed investment strategy which targets a broad universe that includes both foreign (U.S. dollar) and local currency fixed income assets, whether sovereign or corporate. This strategy may provide a solution for investors that want to have exposure to global Emerging Markets, but do not want to conduct their own asset allocation decisions.
Investment Focus
Emerging Markets Fixed Income: The Case for an Opportunistic Investment Approach
CONTRIBUTORS
ERIC BAURMEISTER Managing Director Morgan Stanley Investment Management
JENS NYSTEDTManaging Director Morgan Stanley Investment Management
WARREN MARManaging Director Morgan Stanley Investment Management
JUSTIN MILLERSenior Associate Morgan Stanley Investment Management
NOVEMBER 2015
INVESTMENT MANAGEMENT
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The Evolution of the Emerging Market Fixed Income UniverseThe Emerging Markets Debt (EMD) asset class is comprised of tradable debt issued by sovereign, quasi-sovereign, and corporate issuers based in Emerging Market countries. From the perspective of a global investor, the EMD asset class began with EM governments issuing external debt, initially denominated in U.S. dollars, and eventually euro-denominated as well. As these countries grew in terms of economic prosperity, private sector development, and financial maturity, the asset class evolved to include not only sovereign issuers, but quasi-sovereign and corporate issuers as well. The evolution brought a broadening of issuers and currencies, as governments and corporations sought funding in both external and their own domestic currency.
Historically, global investors primarily invested in the external debt of sovereign and quasi-sovereign issuers. As the EM economies matured, investors became increasingly comfortable with lending to these countries in their own local currency by purchasing domestic debt. At the same time, the private sector began to flourish in an environment where many EM economies were growing at strong growth rates and governments were enacting prudent fiscal policies, which also reduced the governments’ crowding out of private investment and borrowing.
The development of an EM corporate bond market allowed companies to expand their financing options and improved their ability to manage their balance sheets, while at the same time, providing the opportunity for global investors to benefit from debt investments in local market leaders who were coming to prominence on the world stage. EM corporates, and the attractive opportunity they presented, began to be increasingly incorporated into the allocations of dedicated EMD as well as global credit portfolios. At this stage, the EMD asset class could be characterized as three distinct asset classes which provided their own risk / return characteristics: 1. EXTERNAL DEBT: Comprised of EM sovereign and quasi-sovereign bonds issued primarily in U.S. dollars (euro and yen-denominated bonds were also available to a lesser extent).2. CORPORATE DEBT: Comprised of bonds issued by EM companies which were initially U.S. dollar-denominated, but have been increasingly issued in local currency. 3. LOCAL (DOMESTIC) DEBT: Comprised of sovereign and quasi-sovereign bonds issued in local (also known as domestic) currency of the issuer.
The Fundamental Emerging Market Investment Case RevisitedRecently, negative headlines and poor performance have triggered increased scrutiny of EMD. The combination of generally declining terms of trade, slowing economic growth in key trading partners, and a slowdown in potential output has made the outlook for EM more challenging. The core theses behind investing in Emerging Markets, i.e. to invest in the assets of countries that (i) exhibit improving fundamentals / economic growth; (ii) have undervalued exchange rates; (iii) pay high yields; and (iv) diversification benefits, have been challenged in a number of areas. Gone are the days of the BRICS hype.
By 2013, the combination of higher-than-targeted inflation, real exchange rate appreciation, and the lack of structural reforms, led to chronic overvaluation across many Emerging Markets, leaving them exposed to external shocks such as an increase in U.S. Treasury yields (i.e. the Taper Tantrum). Investments in EM local markets have been especially disappointing, as the relatively higher levels of income were not enough to offset significant currency depreciation. Some of the more frequent concerns raised about investing in EM fixed income assets include the following:
• POOR MACROECONOMIC MANAGEMENT MAKES EM COUNTRIES ESPECIALLY CRISIS PRONE: This perception was developed over previous boom / bust cycles; however, many EM governments have learned their lessons from the ‘90s regarding external vulnerabilities and external shocks. Most EM countries have been successful in diversifying their funding sources by developing local debt markets, building up significant foreign exchange reserves (often to levels exceeding their outstanding foreign currency debts), and bringing inflation expectations under control through more prudent fiscal management and a strengthening of a more independent Central Bank.
• STRONG EM GROWTH AND ASSET PERFORMANCE LAST DECADE WAS PURELY A REFLECTION OF A COMMODITY PRICE SUPER-CYCLE: Now that the commodity price cycle appears to be over, a period of EM underperformance should be expected. While it is true that many Emerging Markets are commodity exporters who have benefitted from higher commodity prices, what is less often discussed is that many other EM economies are commodity importers, who could benefit from lower prices. Commodity importers have benefited from the lower prices in the form of cheaper food and energy prices, which has improved their terms of trade
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and also allowed for fiscal reforms through the reduction of energy subsidies. Moreover, many of the benefits accrued from the commodity super-cycle were saved by many of the exporting economies in the form of sovereign balance sheet improvement (i.e. paying down debt and building foreign currency reserves).
• THE EFFECT OF THE FEDERAL RESERVE RISING INTEREST RATES: The end of the commodity super-cycle has brought many of the structural weaknesses to the fore that were previously masked by the cyclical upswing in commodity prices. Similarly, and to some even more concerning, has been many Emerging Markets’ reliance on foreign portfolio investment to finance widening current account deficits. A crucial question is how will these countries fare in the context of a Federal Reserve rate hike cycle that many analysts expect to start in 2015/6? In fact, the Taper Tantrum of 2013 was, for many skeptics of EM, an important trial run of what could happen when global financial conditions tighten.1
In the second half of 2014, and into 2015, during the strong US dollar rally and oil price decline, EM currencies shouldered most of the burden of adjustment, which was viewed as a sign of intrinsic weakness. In fact, allowing exchange rates to adjust has been one of the clear lessons learned from past EM crises and has protected EM competitiveness, foreign exchange (FX) reserves, and has on net, been beneficial. At this stage EMFX, in aggregate, is actually undervalued and many currencies have sold off more than the deterioration in their ToT (terms of trade), signalling an opportunity.
• POOR RECORD ON STRUCTURAL REFORM AFTER A BURST IN THE 90’S AND EARLY 00’S HAS LED TO LOWER POTENTIAL GROWTH: The commonly held belief is that easy financing, through a combination of better ToT and/or ample capital inflows, halted the need to continue with unpopular structural reforms in many countries. The lack of reforms has reduced the ability of EM economies to withstand external shocks as it gave them less room to fiscally manoeuvre.
Figure 1: Adjustment of REER vs. Pre-Taper Tantrum High Terms of Trade (ToT)2
• THE RAPID GROWTH IN PRIVATE SECTOR DEBT TO GDP LEVELS; is particularly concerning if this debt is denominated in foreign currency. The rapid growth poses a threat to EM economies ahead of Fed hikes. While this leverage build-up has been predominantly on the corporate and household balance sheets, sovereign balance sheets are not immune given the contingent liability nature of the debt. At a minimum, the need to de-lever among EM countries is another headwind to growth in the context of a slow global economy. However ample reserve buffers, natural hedges, and prudent borrowing strategies may reduce, but not eliminate, this concern.
2 SOURCE: MSIM, JP Morgan, Bloomberg. Data as at August 21, 2015.1 SOURCE: MSIM – Will there be a Taper Tantrum 2 for Emerging Markets Fixed Income?, Jens Nystedt, Mariano Pando, Armando Rosselli, Teal Emery.
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Counterarguments to the Emerging Market SkepticismThe mixed performance of EM assets over the last few years and the long list of concerns discussed earlier challenge the traditional case for investing in the EM. Hence, it is worthwhile to revisit the case for Emerging Markets, while noting that no EM asset class is likely to outperform in all scenarios. There are now many more classes of instruments to navigate the possible future scenarios for Emerging Markets.
Emerging Markets are not a homogenous set of countries and there are substantial divergences between regions and countries, which in turn provides ample investment opportunities. However, when revisiting the fundamental case for EM investments, there are broad generalizations that we can make:• GLOBAL GROWTH IS TURNING AND EM IS STILL A HIGHER-
BETA PLAY ON GLOBAL GROWTH. Despite recent downward revisions to growth, the rate of EM growth is still expected to be almost twice the growth rate of the advanced economies, with the trough expected this year as advanced economies recover and sharp negative contributions to EM growth from Brazil and Russia ease. The main risk to the EM growth outlook is China, where International Monetary Fund (IMF) forecasts most likely overstate the actual growth outcome in 2015 by at least a percentage point. Nevertheless, Asian growth remains solid and should recover further next year (ex-China), even after China adjusted its currency peg.
• SOVEREIGN BALANCE SHEET FUNDAMENTALS ARE STILL SUPPORTIVE FOR MANY EMS: In advanced economies the rapid increase in debt to GDP levels has often dwarfed the more gradual deterioration in EMs. As a result, the relative difference in debt to GDP levels are to the EM’s advantage and should help mitigate, together with large FX reserves, any ‘Taper Tantrum 2’ type of shocks.3
• IMPROVED VALUATIONS: Following the 2013 Taper Tantrum and U.S. dollar rally / oil price drop, we believe value has re-emerged in many Emerging Markets. In particular, exchange rates, as noted previously, have adjusted significantly and are now, on average, once again cheap across many Emerging Markets. Sovereign spreads are in the upper-end of their recent range and above similarly-rated U.S. corporate spreads. Turning to the EM corporate sector, we find selective opportunities in terms of valuations. Valuations appear stretched in some names, but overall, there is plenty of scope to find sectors / companies that have been overly-hurt by the recent selling pressures and now offer good value.
Figure 2: EM Growth has been Slowing, But Still Above DM4
• POLICY DIVERGENCE ACROSS EMERGING MARKETS: In an increasingly low yield world, Emerging Markets offer some of the highest real yields (see figure 3). 2015 has been a year of policy divergence across Emerging Markets. Many EM countries have been forced to respond to the sharp depreciation of their currencies and its inflation pass-through implications by tightening monetary policy. Hence, in a handful of cases, instead of following the majority of countries that have eased monetary policies, rates were hiked in Brazil, Russia (subsequently cut), and Turkey, although for varying reasons. High carry has attracted increased attention, as the expected Fed rate hike has been pushed further back and the European Central Bank (ECB) and Bank of Japan (BoJ) are still in the midst of their QE programs.
• STRUCTURAL REFORMS: Structural reforms are still largely a missing piece. With the exceptions of a handful of countries that benefited from significant (policy) regime change (India and Mexico), examples of significant structural reforms have been absent. Some countries, such as Indonesia and Malaysia have, however, used the opportunity of lower oil prices to enhance their fiscal frameworks by removing or reducing fuel subsidies, which should enhance the fiscal accounts’ resilience once oil prices rise. Ultimately, a renewed push towards structural reforms will be necessary to avoid the more bearish IMF assessment of a permanent loss in potential output. Such reforms will have to also address governance issues that have come increasingly to the forefront as increasingly
4 SOURCE: MSIM and WEO. Data as at June 2015. Forecasts / estimates are based on current market conditions, subject to change and may not necessarily come to pass.
3 SOURCE: MSIM - Will there be a Taper Tantrum 2 for Emerging Markets Fixed Income?, Jens Nystedt, Mariano Pando, Armando Rosselli, Teal Emery.
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politically active middle classes question past business practices (recently high profile alleged corruption cases include Brazil and China).
Figure 3: Real Yields5
Negative Real Yields = Less Attractive
-1.1 -1.0
0.0
2.32.6
3.0
4.2 4.4
5.3
6.6
Positive Real Yielding Assets = More Attractive
Less Attractive
More Attractive
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
7%
8%
DEV
. HY
EMBI
G
EMD
CO
RP
EMD
Ble
nded
GBI
EM
GD
US
IG
S&P
500
USA
5Y
Japa
n 5Y
DEM
5Y
Case for Investing in EMD through a Opportunistic Investment StrategyEach step forward in the evolution of the EMD asset classes presents increasingly complex decisions for investors to make, with each security, and segment of the market, offering unique opportunities and risks. Investing in EM debt is no longer just about a dollar-denominated asset class in which the investment decision is a combination of credit and country decisions, but now also equally requiring a local currency and domestic rates view. Over and above the need to assess the credit-worthiness of underlying borrowers, successful investing in or across EM requires investors to analyze the monetary policy, local yield curves, currency valuation, and local custody issues in greater detail. This is relevant in investing in sovereign / quasi-sovereign, or corporate debt, the latter requiring not only the top-down country perspective but additional research into the credit fundamentals of the individual companies.
As of today the total bond stock of EMD stands at over $14.3 trillion U.S. dollars6, with an investable universe (as measured by the most widely followed benchmarks) of almost $2.5 trillion U.S. dollars. The evolution of these large, diverse, and increasingly idiosyncratically-driven markets has only added to the importance of possessing the adequate depth of resources required to navigate these markets. Similar to what we’ve seen in other equity and fixed income markets, well-resourced EM investment managers are helping investors to find the best opportunities no matter where they present themselves. Given the depth and size of the asset class, that spans over 70 countries and 500+ companies, it is critical to have a deep pool of resources that cover the entire investment universe to identify the best opportunities, and build a portfolio that provides the optimal solution for clients.
6 SOURCE: JP Morgan.
5 SOURCE: Bloomberg, MSIM. External Debt represented by the JPM EMBI Global Index, Domestic Debt represented by the JPM GBI-EM GD Index, and Corporate Debt represented by the JPM CEMBI Broad Index. DM Global Govt. Ex-US represented by the JPM GBI Global Index, HY Corp represented by the JPM High Yield Index, US Equity represented by the S&P500, EM Equity represented by the MSCI EMF Index, UST 5Y represented by 5 year US Treasury bond, DEM 5Y represented by German government 5 year bond. Data as of August 24, 2015.
NOTE: Real yields are the nominal yield of the asset less country specific CPI inflation (US = 2%, GER = 0.4%). Dividend yields are viewed as real because inflation is already netted out.
Past performance is not indicative of future results. It is not possible to invest directly in an index Provided for illustrative purposes only and are not meant to depict the performance of a specific investment. See back page for index definitions.
EMD Equal-weighted Index is a theoretical equal weighted allocation composed of (roughly 1/3 each) of the JP CEMBI Broad Index, the JPM EMBI Global Index, and the JPM GBI-EM Global Div. indices.
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Figure 4: Annual Total Returns7
-20
-15
-10
-5
0
5
10
15
20
25
30
35
2014201320122011201020092008200720062005
EM Corporate Debt EM External DebtEM Domestic Debt
Tota
l Ret
urn
%
EM Blended
Figure 5: Investment Flows8
EM External EM Domestic EM Blended
Fund
Flo
ws:
Scal
ed to
100
as
at Ja
n 20
07
May-15
0
100
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300
400
500
Jul-14Jun-13May-12Apr-11Mar-10Feb-09Jan-08Jan-07
7 SOURCE: Bloomberg, JP Morgan, MSIM. Data as at December 31, 2014.8 SOURCE: EPFR. Data as at May 2015.
Generally, investors have preferred to determine their own asset allocation to the individual EMD markets, but following the weakness of EM currencies since mid-2013, investors have started to increasingly favor the flexible approach. A simple static equal weighted allocation has offered a favorable risk-return profile, and we believe active management could offer an even higher return potential by selecting the best opportunities between external, domestic, and corporate bonds.
Figure 6: Annual Total Return: % Emerging Markets Debt9
IndexJPM CEMBI
Broad Div. IndexJPM EMBI
Global Index
JPM GBI-EM Global
Div. Index EM Blended
Asset Class
EM Corporate Debt (Corp)
EM External Debt (Ext)
EM Domestic Debt (Dom)
EMD Equal-weighted Index
2005External
10.73
EMD Equal-weighted Index
7.72
Domestic 6.27
Corporate 6.10
2006Domestic
15.22
EMD Equal-weighted Index
10.57
External 9.88
Corporate 6.53
2007Domestic
18.11
EMD Equal-weighted Index
9.33
External 6.28
Corporate 3.91
2008Domestic
-5.22
EMD Equal-weighted Index
-10.64
External -10.91
Corporate -15.86
2009Corporate
34.88
EMD Equal-weighted Index
28.38
External 28.18
Domestic 21.98
2010Domestic
15.68
EMD Equal-weighted Index
13.66
Corporate 13.08
External 12.04
2011External
8.46
EMD Equal-weighted Index
3.01
Corporate 2.32
Domestic -1.75
2012External
18.54
EMD Equal-weighted Index
16.87
Domestic 16.76 Corporate 15.01
2013Corporate
-0.60
EMD Equal-weighted Index
-5.39
External -6.58
Domestic -8.98
2014External
5.53Corporate
4.96
EMD Equal-weighted Index
1.52
Domestic
-5.72
9 SOURCE: Morgan Stanley Investment Management, Bloomberg, JP Morgan. Data as at December 31, 2014.
NOTE: Real yields are the nominal yield of the asset less country specific CPI inflation (US = 2%, GER = 0.4%). Dividend yields are viewed as real because inflation is already netted out. Past performance is not indicative of future results. It is not possible to invest directly in an index Provided for illustrative purposes only and are not meant to depict the performance of a specific investment. See back page for index definitions.EMD Equal-weighted Index is a theoretical equal weighted allocation composed of (roughly 1/3 each) of the JP CEMBI Broad Index, the JPM EMBI Global Index, and the JPM GBI-EM Global Div. indices.
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Figure 7: Historical Volatility – Rolling 250 Days Standard Deviation10
RETURNS: Figure 4 details the historical annual total return performance of the three EMD asset classes (external sovereign & quasi-sovereign debt, domestic debt, and corporate debt), as well as a theoretical allocation (roughly 1/3rd each) including each individual segment. While no single segment outperforms in every year, we believe active management of the allocation could add additional benefits.
VOLATILITY: Figure 7 plots the rolling 36-month volatility (%) of the individual EMD segments, as well as the equal weighted allocation, which has exhibited lower volatility than many of the individual segments (see figure 7).
DIVERSIFICATION BENEFITS: EMD Equal-weighted Index debt has offered diversification benefits to both fixed income and equity portfolios (see figure 8).
10 SOURCE: MSIM, JP Morgan, data as at July 2015. 11 SOURCE: MSIM, Morningstar Direct. Data 10 years ending 31 July 2015.NOTE: Real yields are the nominal yield of the asset less country specific CPI inflation (US = 2%, GER = 0.4%). Dividend yields are viewed as real because inflation is already netted out.Past performance is not indicative of future results. It is not possible to invest directly in an index Provided for illustrative purposes only and are not meant to depict the performance of a specific investment. See back page for index definitions.EMD Equal-weighted Index is a theoretical equal weighted allocation composed of (roughly 1/3 each) of the JP CEMBI Broad Index, the JPM EMBI Global Index, and the JPM GBI-EM Global Div. indices.Investing involves risks including the possible loss of principal. In general, fixed income investments are subject to credit and interest rate risks. High yield investments may have a higher degree of credit and liquidity risk. Foreign securities are subject to currency, political, economic and market risks. The risks of investing in emerging market countries are greater than investments in foreign developed countries. Investors should carefully review the risks of each asset class prior to investing. For risks considerations of the fund, please refer to the disclosures at the back and the fund’s prospectus.
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Strategic Investment OutlookEM countries have come a long way over the last 20 years in terms of their macroeconomic stability and better policy management. Sovereign balance sheets have improved across the board, reducing systemic risks, but there is still plenty of room for additional structural reforms. Moreover, the types of fixed income instruments available to gain exposure have also evolved and matured. We are in an unprecedented period of near-zero interest rates in DM, and the significant yield pick-up offered by EM assets is potentially attractive for those investors comfortable with the risks of investing in Emerging Markets. Moreover, the external scenario with low global growth, a strengthening U.S. dollar, low commodity prices and the potential for Fed hikes and continued easing by the European ECB and BoJ has set the stage for continued divergence in performance.
For investors in EM, the main question is which EM asset class will outperform, and under what external scenario? Subsequently, within the asset class, the right assets have to be identified that are likely to win or lose given the external macro-economic scenario and the fundamentals of the sovereign or corporate in question. Given the current themes driving EM fixed income investments, it is, in our view, important to be flexible and have the ability to re-allocate to the asset class that is likely to perform the best. For example, against a backdrop of broad U.S. dollar strength, EM currencies are still likely to weaken and our opinion may be the right choice for investors to express fundamentally constructive views towards EM through U.S. dollar -denominated bonds, either sovereign, corporate, or both.
A strategy that has the flexibility to ‘go anywhere’ may offer the potential to deliver returns throughout a challenging and changing environment. As displayed in Figure 6, no single EM asset class outperforms in all environments. Active management could potentially improve on that attractive track record.
Looking ahead, we think the following themes should help determine an investors EM fixed income asset allocation: • GLOBAL GROWTH AND TAIL RISKS: We are cautiously
optimistic on EM growth in 2016 due to a lack of a repeat of some truly disappointing growth events in 2014 and 2015 (for example Russia, while the slowdown in Brazil is still gathering steam). Despite the recent disappointments in terms of global growth in DM and EM alike, the negative tail risks are mostly focused on China. We do not expect sub-6% in China this year or next, which is typically seen as a hard landing. However, 6%+ growth necessitates further aggressive policy support using both monetary and fiscal tools. However, the risk is that we are wrong on the downside rather than upside. Turning to DM, both the Eurozone and Japan are showing decent signs of recovery. U.S. growth seems to have stabilized at a moderate, unexciting level. We continue to expect a further modest recovery, but overall economic performance is likely to remain towards the lower end of current expectation and keep inflationary and wage pressures well in check.
• TIMING OF FED LIFT-OFF AND SUBSEQUENT HIKING PATH: Given the well-telegraphed message from the Fed, we do not believe we will see a repeat of May / July 2013’s Taper Tantrum. However, there will likely be some volatility around the Fed lift-off that should allow for interesting relative value opportunities as some EM countries and currencies are more vulnerable than others. Back in May 2013, positioning in EM assets was at its peak and had attracted significant amount of non-dedicated and retail investments. Moreover, BoJ’s launch of QE earlier in the month supercharged a strong rates rally in EM to levels that were clearly extended in retrospect. We saw close to $30 billion U.S. dollars of outflows from local EM markets, or nearly 10% of the tracked AUM. These flows have not come back, which we believe makes the market more stable in the event of an increase in long end U.S. yields. At this stage, what is more important, rather than the exact timing of Fed lift-off, is the pace of rate hikes once the Fed starts and where it will end its hiking cycle. Given the mounting concerns about lower GDP growth in both the U.S., and across the globe, as well as the largely absent inflationary pressures, the Fed’s estimated equilibrium neutral Fed Funds rate has steadily declined, but still remains above market consensus.
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• THE OUTLOOK FOR THE BROAD USD: A strong U.S. dollar view has a direct impact on the top-down EM asset class choice. In 2014, and so far in 2015, the right view has been that a stronger U.S. dollar would in turn trigger weakness in EMFX. Most EM going into 2014 experienced overvalued exchange rates and were vulnerable to both a stronger U.S. dollar and valuation concerns. Carry was insufficient to compensate investors in local currency debt for the adjustment that was increasingly necessary. The consensus view going into 2015 was that a stronger U.S. recovery would imply tighter U.S. monetary policy, which in turn should support an ongoing broad U.S. dollar rally. ECB QE only added to the strong U.S. dollar view. However, given broad initial U.S. growth disappointment and re-assessment of the timing of liftoff, the U.S. dollar rally has stalled for now and given the sharp depreciation in EMFX and the higher yields being offered by local currency government bonds, in our opinion there are now selective opportunities to return to local currency investments.
• COMMODITY PRICES: These are intrinsically linked through the invoice currency channel and global growth. We would expect oil prices to stabilize around current levels and then gradually rebound as global growth shows more vigor in 2016. Aggressive policy measures in China and the promotion of more resource intensive investment projects should also help put a floor on global commodity prices, especially hard metals. As a result, we believe that global commodity prices that have been a headwind for most of 2014 and 2015 should be largely neutral for EM assets in Q4 and then turn outright positive in 2016.
Conclusion Given the above themes, we believe that a ‘‘go anywhere” strategy should continue to overweight hard currency assets, however, individual securities should only be selected upon strong bottom-up qualities. Despite favoring hard currency assets, we are looking to add selective local currency exposures where we think there is attractive risk / reward and where we feel we are compensated for what are still significant risks. Only an actively managed strategy for Emerging Market fixed income investment could offer exposure to all these opportunities.
Such an investment approach provides a single vehicle solution investors seeking to:• Take the opportunity to capitalize on the current and most
relevant strength and development of EM economies• Add benefits to a portfolio, including: diversification,
additional yield, and return potential• Take advantage of a smoother ride for EMD investors as the
pitfalls within the individual market segments can potentially be mitigated
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Investment TeamThe established Emerging Markets Debt team is comprised of managers, analysts, and traders who possess deep experience and offer complementary skill sets. With over 100 years of combined tenure, the team has investment experience spanning a variety of market conditions, including particularly volatile periods. In addition to the macroeconomic, sovereign, and credit analysts dedicated to the Emerging Markets universe, the team also draws on the wider expertise of the Global Fixed Income Team.
About Morgan Stanley Investment Management12
Morgan Stanley Investment Management, together with its investment advisory affiliates, has 585 investment professionals around the world and approximately $403 billion in assets under management or supervision as of June 30, 2015. Morgan Stanley Investment Management strives to provide outstanding long-term investment performance, service and a comprehensive suite of investment management solutions to a diverse client base, which includes governments, institutions, corporations and individuals worldwide. For more information, please visit our website at www.morganstanley.com/im.
12 SOURCE: Assets under management as at June 30, 2015. Morgan Stanley Investment Management is the asset management division of Morgan Stanley. Assets are managed by teams representing different Morgan Stanley Investment Management legal entities; portfolio management teams are primarily located in New York, Philadelphia, London, Amsterdam, Singapore and Mumbai offices. Figure represents Morgan Stanley Investment Management’s total assets under management / supervision.
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IMPORTANT INFORMATION
This communication is a marketing communication. The document has been prepared solely for information purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The material contained herein has not been based on a consideration of any individual client circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.
Except as otherwise indicated herein, the views and opinions expressed herein are those of the portfolio management team, are based on matters as they exist as of the date of preparation and not as of any future date, and will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date hereof.
Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto. All indices referenced are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.
Index Definitions
• EMD External Debt is measured by the JPM EMBI Global TR USD Index. The JP Morgan Emerging Markets Bond Index Global (EMBI Global) tracks total returns for traded external debt instruments in the emerging markets, and is an expanded version of the EMBI+. As with the EMBI+, the EMBI Global includes US dollar-denominated Brady bonds, loans, and Eurobonds with an outstanding face value of at least $500 million.
• EMD Domestic Debt is measured by the JPM GBI EM Global Composite TR USD Index. The JP Morgan GBI-EM Global Diversified Index is a market capitalization weighted, liquid global benchmark for US-dollar corporate emerging market bonds representing Asia, Latin America, Europe and the Middle East / Africa.
• EMD Corporate Debt is measured by the JPM CEMBI BD Index. The JP Morgan CEMBI Broad Diversified Index is a global, liquid corporate emerging-markets benchmark that tracks U.S.-denominated corporate bonds issued by emerging-markets entities.
• EMD Equal Weighted Index is measured by the 1/3 each JPM EMBI/CEMBI/GBI-EM Index. All index descriptions depicted above.
• U.S. Investment Grade Credit is measured by the Barclays US Corp IG TR USD Index. The Barclays U.S. Corporate Index is a broad-based benchmark that measures the investment grade, fixed-rate, taxable, corporate bond market.
• U.S. High Yield Credit is measured by the Barclays US HY 2% Issuer Cap TR USD Index. This Index measures the performance of High Yield corporate bonds, with a maximum allocation of 2% to any one issuer.
• Developed Market Sovereign is measured by the JPM GBI Global Traded TR USD Index. This index is a market capitalization weighted index consisting of regularly traded, fixed-rate government bonds from Developed Markets.
• UST 5-7 is measured by the Barclays Treasury 5-7 Yr TR USD Index. The Barclay’s U.S. Treasury Index includes public obligations of the U.S. Treasury with remaining maturities between five and seven years.
• Emerging Markets Equity is measured by the MSCI EM NR USD Index The MSCI Emerging Markets Net Index is a free float-adjusted market capitalization weighted index that is designed to measure equity market performance of emerging markets. The term “free float” represents the portion of shares outstanding that are deemed to be available for purchase in the public equity markets by investors. The MSCI Emerging Markets Net Index currently consists of 23 emerging market country indices. The performance of the Index is listed in U.S. dollars and assumes reinvestment of net dividends.
• U.S. Equity is measured by the S&P 500 TR USD Index. The S&P 500 Total Return Index is an index that consists of 500 stocks chosen for market size, liquidity and industry group representation. The S&P Index is a market value weighted index with each stock’s weight proportionate to its market value. The S&P Index is one of the most widely used benchmarks of U.S. equity performance. The performance of the S&P Index does not account for any management fees, incentive compensation, commissions or other expenses that would be incurred pursuing such strategy. Total return provides investors with a price‐plus‐gross cash dividend return. Gross cash dividends are applied on the ex‐date of the dividend.
All information contained herein is proprietary and is protected under copyright law.
INVESTMENT VIEW
NOT FDIC INSURED OFFER NO BANK GUARANTEE MAY LOSE VALUE NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY NOT A DEPOSIT
Past performance is not a guarantee of future performance. There can be no assurance that the Strategy will achieve its investment objectives. Portfolios are subject to market risk, which is the pos¬sibility that the value of the investments and the income from them can go down as well as up and an investor may not get back the amount invested. Accordingly, you can lose money investing in this strategy. Please be aware that this strategy may be subject to certain additional risks. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest pay¬ments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall. In a declining interest-rate environment, the portfolio may generate less income. Investments in foreign markets entail special risks such as currency, political, economic, and market risks. The risks of investing in emerging market countries are greater than the risks generally associated with investments in foreign developed countries.
High yield securities (“junk bonds”) are lower rated securities that may have a higher degree of credit and liquidity risk. Mortgage- and asset-backed securities are sensitive to early prepayment risk and a higher risk of default and may be hard to value and difficult to sell (liquidity risk). They are also subject to credit, market and interest rate risks. Municipal securities are subject to early redemption risk and sensitive to tax, legislative and political changes. Sovereign debt securities are subject to default risk Collateralized mortgage obligations (CMOs) can have unpredictable cash flows that can increase the risk of loss. Public bank loans are subject to liquidity risk and the credit risks of lower rated securities. Derivative instruments can be illiquid, may disproportionately increase losses and may have a potentially large negative impact on the portfolio’s performance. Restricted and illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk). In addition to the risks associated with common stocks, investments in convertible securities are subject to the risks associated with fixed-income securities, namely credit, price and interest-rate risks.
Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, correlation and market risks. Nondiversified portfolios often invest in a more limited numberof issuers. As such, changes in the financial condition or market value of a single issuer may cause greater volatility
This communication is only intended for and will be only distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations.
There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. Prior to investing, investors should carefully read the relevant offering document(s).
There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. There are important differences in how the strategy is carried out in each of the investment vehicles. Your financial professional will be happy to discuss with you the vehicle most appropriate for you given your investment objectives, risk tolerance, and investment time horizon.
Please consider the investment objective, risks, charges and expenses of the fund carefully before investing. The prospectus contains this and other information about the fund. To obtain a prospectus, download one at morganstanley.com/im or call 1-800-548-7786. Please read the prospectus carefully before investing.
The document has been prepared solely for information purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The material contained herein has not been based on a consideration of any individual client circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.
Separate accounts managed according to the Strategy include a number of securities and will not necessarily track the performance of any index. Please consider the investment objectives, risks and fees of the Strategy carefully before investing. A minimum asset level is required. For important information about the investment manager, please refer to Form ADV Part 2.
