Eerdmans stress tests EM portfolio for further eurozone deterioration

Emerging market asset prices are continuing to be dominated by risks emanating from the developed world, leading to a sharp increase in volatility in recent weeks, says Peter Eerdmans, who manages the Investec Emerging Markets Debt  fund, a pick of Citywire Selection.

Eerdmans said eurozone debt fears, along with weaker data out of the US and China, were continuing to dominate the macro environment, although the sharply falling oil price should lower inflation worries. 'The key risks to the market are still likely to come from Europe, and we are preparing for a volatile and unsettled markets in the months to come,' he said.

Although cautiously optimistic that Europe will move nearer to closer fiscal coordination, Eerdmans said the process was likely to be long and drawn out, with high levels of political uncertainty.

Due partly to further volatility fears, the fund's overweight position in emerging market foreign exchange exposure has been reduced in recent weeks, and despite emerging market currencies looking relatively cheap, he warned that they could still fall further. 'While emerging market currencies look cheap at current levels, we are cognisant if the fact that they have room to weaken if the euro crisis worsens,' he said.

Learning from 2008

Eerdmans is using the experience of 2008 to look at potential market volatility should there be a disorderly Greek exit from the eurozone and an ensuing collapse in market confidence. He concludes that markets are far more prepared in 2012 than they were in 2008, with exposure to eurozone bank and credit and exports lower, and with many currencies already experiencing significant depreciations, especially in the Europe, Middle East and Asia region.

Those emerging market currencies most exposed to commodities and the eurozone, such as Russia, Poland and Hungary, have fared worst in recent months.

Portfolio manager Werner Gey van Pittius said: 'Currencies have come off which is good news for growth. It supports the export market and helps the manufacturing base. A lot of those markets are factoring in rate cuts now.

'We see value in emerging market debt relative to emerging market bonds, although that doesn't mean we think we will see a rally, but we do think developed market bonds are overvalued.'

Gey van Pittius said that positions in Polish debt had been reduced on expectations of a rate increase, while the overweight in Brazil's local bond market is being maintained as the Brazilian real continues to weaken in a deliberate attempt to prevent a further devaluation if the macro environment deteriorates further.  

Elsewhere, the fund holds a small tactical overweight to Chilean bonds, which have been resilient, while reducing the Chilean currency overweight to neutral, and switching it into the Mexican peso which has underperformed the Chilean peso.

Renminbi overweight remains

With China's official inflation levels down at 3% and economic activity slowing at the margins, the fund remains overweight to the renminbi following the government's first cut in lending and borrowing rates since 2008.

'The Chinese rate cut was coupled with changes in the lending/borrowing rates which commercial banks are allowed to apply, resulting in lower net interest margins for the banks, which is seen as a natural progression towards liberalisation.'