Capital Group: High alert for EM default

By Denise Wee

Added 3rd February 2016

There’s a high likelihood an emerging market country will default on its debt, and the impact on the asset class depends on which country defaults, according to Kirstie Spence, fixed income portfolio manager at Capital Group.

Capital Group: High alert for EM default

“The likelihood of a big EM country going into default is fairly high,” said the London-based Spence at a recent media briefing in Hong Kong.

Spence has about two decades of investment experience, spanning several emerging market debt crises, including that of Argentina, Brazil, Mexico and Russia.

She told reporters that whether such an event would have a knock-on impact on the asset class would depend on which country defaults. For example, if Venezuela were to default, it would likely have a limited market impact. But if Brazil were to default, that would be a different story, she said.

“Brazil is a bastion of emerging market debt. It is broadly-owned, because it’s big, too big to ignore. The pressures on Brazil are one of the single biggest risks to emerging markets today,” she said.

Spence said that Capital Group, which manages $1.3 trn of assets, has seen retail investors pull out money of its emerging market funds. On the institutional investor front, the asset manager has seen both inflows and outflows into its emerging market funds.

"The pressures on Brazil are one of the single biggest risks to emerging markets today"

“Yes, we had some redemptions and clients sometimes need money or they get nervous. But we have also seen clients put more money into the funds. The long-term real investor also looks through the short-term asset price weakness,” she added.

She added that emerging market valuations are attractive at the moment. 

Closer to the region, she and her colleagues worry about China and the ability of the mainland government to manage a gradual deprecation of the renminbi.

Investors have been jittery since last year, when the Chinese government unexpectedly devalued the renminbi by 2% in August. Since then, the renminbi has been under pressure and the Chinese central bank has been using its foreign exchange reserves to defend the currency. Investors are nervous about what could go wrong.

“There is a school of thought that believes it would be easier if China devalued by 10%-15% at one go. That gets it out of the way and the market breathes a sigh of relief and we can all move on,” said Spence.

However, she added that such a large devaluation in the renminbi would cause a lot of nervousness, particularly in China.

“You [could] have suddenly either a run on the banks or people trying to move money because it’s not what’s been expected. Suddenly [authorities] can’t control a 10-15% move and it becomes a 25% -30% and that would be very frightening,” she added.

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