Emerging markets are rarely uneventful, with no shortage of idiosyncratic risks that require constant vigilance. These events can dominate investor thinking, making it easy to neglect the broader opportunity the asset class offers.
Indeed, there are parts of the emerging market complex that can provide a relative safe haven for investors, bringing both stability and diversification benefits. In our view, the Middle East is such a region, and it merits more attention than it typically receives, not to mention a higher portfolio allocation.
Last year was largely defined by challenges in emerging markets’ fixed income asset class, with headwinds from rising interest rates in the United States and country-specific fissures in the likes of Argentina and Turkey. Against this backdrop, Middle East fixed income - and here I mean the countries of the GCC - provided a relative point of calm. In 2018, corporate bonds from the Middle East returned 0.2 per cent, compared to -1.2 per cent for the emerging market corporates benchmark as a whole, and -1.0 per cent for the Bloomberg Barclays Global Aggregate Corporates Index.
In 2019, global fixed income will remain in the crosshairs of prevailing uncertainties of economics and politics around the world, in particular regarding US-China trade relations. As such, bond investors can still benefit from a higher allocation to GCC markets, which should be somewhat buffered from that uncertainty. From within the region, I would note that GCC governments continue to take bold policy steps regarding both fiscal reforms and efforts to diversify their economies away from energy. While the politics of the region remain complex, we expect a more constructive tone to emerge in time. Finally, there is the supportive technical aspect of the countries’ inclusion in the leading JP Morgan ‘EMBI’ indices over the course of 2019, which we expect will lead to a significant increase in investor interest and demand for their bonds.
At Fisch, we recently spent time in the Middle East, meeting companies, sovereign debt management offices and local contacts. To us, such trips are an invaluable resource as we look to continually refine and improve our understanding of, and investments in, emerging markets.
What were our key takeaways this time round?
Three things stood out. First, that while some sectors are performing better than others, there remain plentiful investment opportunities among the issuers of corporate bonds in the region; second, that the region’s governments and government related entities are becoming more open and practised in their dealings with the investor community; finally, that the depth and diversity of investor interest in the region is already expanding dramatically.
All that said, we are cognisant of some of the issues facing the region in 2019. Firstly, issuance from governments and government-related entities will be substantial. We have already seen Saudi Arabia and Qatar come to the market this year with multi-billion dollar debt issuances, and Saudi oil champion Aramco is expected to issue a similar amount soon. Secondly, the politics of the region remain complex, though we expect a more constructive tone to emerge in time. Oman will also have need of the markets. Oil price remains a key driver of the region’s credit status. While we are constructive in the near-term here, with Opec set to continue to deliver cuts to its output, over the longer term a potential rise in US shale output could require further discipline from the governments of the Middle East.
All that said, we remain optimistic on Middle East fixed income in 2019, buoyed by a supportive oil price, an ever-more diverse issuer set, increased investor demand, and a region at a remove away from the challenges of east-west relations. In short, there are a number of positive characteristics that make the region attractive, and merit an increased portfolio allocation.
Theodore Holland is Senior Portfolio Manager at Fisch Asset Management, a member of The Gulf Bond and Sukuk Association.