Pacific Investment Management Co. has some advice on where investors should be positioned when the year-and-a-half bull run in emerging markets comes to end at some point.
The “Australian Dream” is the shorthand for countries with strong institutions where external imbalances are low and inflation expectations are under check and the world’s second-biggest bond manager is advising clients to seek out that area of the market. A weaker currency won’t translate into a rout in local notes in places that meet the criteria — like India, Indonesia and Poland.
Any ramping up of global trade protectionism, higher U.S. interest rates and a stronger dollar, makes countries like Turkey, Colombia and Brazil particularly vulnerable and the idea is that investors should avoid such countries in times of weakness. However, according to Gene Frieda, a London-based global strategist at Pimco, which oversees about $1.5 trillion of assets, emerging economies begin to resemble more developed ones, susceptible countries used to be known as the “Fragile Five” are decreasing in number.
“There’s a much larger contingent of emerging-market economies living the Australian Dream today,” Frieda said. “Their currencies have the capacity to weaken without blowing up the bond markets.”
While Frieda said distinguishing among developing nations will be more important as the rally loses its legs, Pimco still considers emerging markets the “cheapest asset class” for now — benefiting non-Australian Dream assets such as Brazilian local notes.
Emerging economies were mired in crisis when the concept of the Australian Dream was first described by Harvard economist Ricardo Hausmann at a conference in 1999. A global economy where currency shocks in developing countries didn’t send bond investors rushing to the exits was his vision. While it was firmly in the developed-nation category, with a semi-volatile currency but more stable bonds, Australia served as a model.
Goldman Sachs Group Inc. revived it in a 2014 note to clients even though the use of that term didn’t really catch on in the subsequent decade.
Andrew Keirle, who oversees more than $1 billion for T. Rowe Price’s fixed-income division said that a greater ability to withstand trade shocks, improving external balance sheets and predictable governments and central banks are possessed by a typical Australian Dream nation.
While their benchmark local bonds dropped much less and as currencies in Hungary, Romania and Poland weakened between 6.8 percent and 8.7 percent against the U.S. dollar, that was seen in last year’s fourth quarter.
According to Jan Dehn, the head of research at London-based Ashmore Group Plc, which oversees about $52 billion of assets, the increasing percentage of bonds held by domestic buyers also acts as a buffer during selloffs with foreign investors underweight emerging-market local notes.
According to data compiled by Bloomberg, while average local bond losses were 7.3 percent, and when developing-nation currencies depreciated by about 14 percent, that occurred from the eve of the taper tantrum in May 2013 through December 2015.
“If that did not blow up their bond markets, nothing will,” Dehn said
(Adapted from Bloomberg)