September 2021 – Three Loud Macro Bells

Portfolio Manager comment Coeli Frontier Markets Fixed Income September 2021

The fund lost 1.04% gross of fees in performance in the third quarter. Performance in September was a negative 2.51% and that moved the quarter into negative territory.

The quarterly performance was defined by a very weak finish based on a (i) China driven macro risk off, almost simultaneous rise in (ii) US interest rates by 20bps in the last week of September and finally a return of (iii) inflation fears. As a result, both the high risk positions as well as our low risk positions had negative performance. The later have higher rate sensitive and therefore contributed negatively to performance.

In China (i), the realization that the second largest property developer with over $300 billion in debt would default without the government supporting investors scared investors. The company debt is reported to represent 2% of China’s GDP, so the consequences of a collapse of the developer and property markets will have substantial consequences for China’s banks and investors in China. We do not invest in China. Frontier issuers however do rely on Chinese demand for their products and Chinese funding in some cases.

As for point (ii), the US Fed announced intentions of tapering and thereby expectations of interest rate increases shot up. This was a highly negative event for investment grade rated emerging market debt. Frontier markets were effected on the defensive side but also by resulting outflows from emerging market funds.

Finally (iii), we have seen inflation fears return to the market with numerous headlines regarding record prices and actual shortages in gas across UK, India and China.

Despite the energy inflation fears leading to the risk off sentiment and adding to rising interest rate expectations, we actually expect this to be relatively positive for Frontier markets, as they are used to supply disruptions but also a number of our issuers are energy exporters. Further, relative to emerging markets we expect Frontier markets to shine due the high coupons our issuers offer and lower rate sensitivity. With troubles in China, the appeal of Asian credit is likely to wane in favour of other high yield asset classes, like Frontier markets.

Our overall optimistic expectations for the Frontier market space is represented by our current risk level of 123% in the fund at quarter end.

In terms of country specific performance drivers in the portfolio in Q3: Zambia’s bonds returned over 20% as the opposition leader won elections and power was transferred without violence. Zambia was our best performer and was also our largest relative risk position in the fund. The fund also benefited by its position in defaulted Lebanese bonds which returned in excess of 30% in September on the back of a government being formed. The weakest performing country in the fund was our position in El Salvador. The country needs support from the IMF. The president has however soured the relationship with the IMF and US on back of his reforms, introduction of bitcoin and strengthening of his control. We remain constructive, though we have been too early in adding to our position.

Top 3 and Bottom 3 Contributors in Q3

Source: Coeli; Bloomberg; Based on Q3 2021 contribution to the fund’s performance

In the third quarter we added two new exposures in the fund. Firstly, we participated in the issuance in the Maldives at 10.5% on the back of revival in tourism and multilateral support. Secondly, we participated in Egypt’s new issuance at attractive valuations of over 8%.

We also added to our exposures in Jordan, Nigeria, Kenya, Pakistan, El Salvador, Senegal and a Mongolian corporate during the quarter. We funded these changes by reducing our positions in Jamaica, Angola and Mongolia.

On the ESG front, we now have two active engagements with two frontier issuers in order to encourage future use of sustainable bonds. Further, the fund participated in a “blue” restructuring of our small position in Belize bonds with a gain of over 20% on our initial investment. As part of the tender of our bonds, the government will need to set aside $23 million for protection of the local coral reef.

The largest positions in the fund remain Ghana, Nigeria, and Sri Lanka.

With the substantial drop in September and resulting attractive valuations, market participants expect Frontier and emerging markets to gain focus from investors. Also as previously written, we await in Q4 details of how the re-distribution of $100 billion from the G7 SDR allocation towards the weakest nations will be approached. October is also when investors will participate in sessions with the various IMF delegations and issuers.