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With Emerging-Markets Sell-Off, Opportunity in Corporates

Penny Foley of TCW Emerging Markets Income discusses the emerging-markets' debt spectrum and the fund's allocation to EM local debt.


Karin Anderson: Hi, my name is Karin Anderson. I'm the associate director for fixed-income strategies at Morningstar. I'm here today with Penny Foley, who's a portfolio manager of the Silver-rated TCW Emerging Markets Income Fund.

Hi, Penny, how are you?

Penny Foley: I'm well, Karin. How are you?

Anderson: Great. Thanks for being here.

Foley: Thanks for having me.

Anderson: Your flagship fund invests across the emerging-markets' debt spectrum, hard currency debt, local currency debt and corporates. Can you tell us a little bit about where you're finding opportunities right now, given that the asset classes come under some pretty significant pressure?

Foley: As you say, we've had quite an interesting sell-off in emerging-markets, fixed-income assets in the last eight weeks, particularly painfully in the local currency side, but also in dollar debt. Corporates, on the other hand, have held up pretty well. They've outperformed both the MB and the local currency index. What we've done during that period is to look for opportunities where things have gotten sold off and sell things that have held in pretty well. We've actually been selling corporates. Corporates had been about 26% or 27% of the portfolio now down to 22% just because they've held in so well, and buying things that have gotten beaten up like in Argentina, which got beaten up on the back of imbalances that had built up and the need to finance externally. They have gone to the IMF, have negotiated a $50 billion program, which really takes them out of the international markets for two years. We've been selling corporates and buying dollar Argentine government debt.

We like those stories when you've got that sort of anchor, whether it's the IMF or a strong reform program. Egypt is another place we like very much at this point. Again, with an IMF anchor and improving economic backdrop, if you will. We like South Africa, which has gone through a political transition, which in our view will lead to significantly better economic policy. In the investment-grade space we like Middle Eastern countries that are A credits, trading at sort of BBB minus levels. So, we find a lot of value in that area, as well. In Asia, we're underweight, but overweight India and Indonesia, which are two countries with higher yields and a strong reform momentum.

Anderson: Also curious to know about your current allocation to emerging-markets' local debt and that fund. You can own up to 25%, 30% of the fund in those EM currencies, but I think it's only about 5% now. Can you talk about why that is?

Foley: That's correct. We started the year in 2018 with an allocation of about 15% to local currency. We thought the local currency story was very interesting at that point. You were looking at a spread between yields and local currency and yields in the dollar markets of about 100 basis points. At the same time, currencies had sold off substantially since the 2013 taper tantrum and we felt you could see, maybe another 1% to 2% on top of that from currency appreciation. What happened in the first quarter is what we expected to happen in a full year. That spread between dollar and local currency, interest rates closed up entirely. You had local currency outperform dollar debt by about 600 basis points. At that point we said everything we thought would happen has happened. Let's pull that down.

We've pulled down our local currency exposure in our total return fund to as low as 3% currently, and we would be looking for opportunities to add as markets calm down a little bit. I think the first place we'd add is to the course in the dollar fund which less volatility and some very interesting opportunities created by the sell-off. But I think local currency, which has sold off even more, offers some pretty interesting opportunities, just a little more volatility in the short term.

Anderson: Great. Thank you so much, Penny, for sharing these insights.

Foley: Thank you.

Karin Anderson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.