OC TOBER 2019 1

Emerging Markets Sovereign Debt: Does Active

Management Pay?

The performance of Emerging Markets Sovereign Debt can—and does—vary widely from

country to country. In this piece, Barings’ Cem Karacadag explores how an active approach

can be key to selecting the most attractive opportunities, while also avoiding the bad apples.

While general market conditions for emerging markets debt (EMD)—conventionally known as market beta—may be the main

driver of EMD returns over short time horizons (days or weeks), idiosyncratic country fundamentals and risks ultimately

drive prices and performance over the long term. As a result, there is sizable dispersion in the total returns on the debt of

70+ emerging market sovereigns in the J.P. Morgan EMBI Global Diversified (EMBIGD) bond index.

BARINGS INSIGHTS

FIXED INCOME

BARINGS INSIG HT S OC TOBER 2019 2

In the first three quarters of 2019, for instance, the EMBIGD returned 12.9%.1 While the great majority of EM sovereigns

generated positive returns, some countries’ debt returned significantly more than others’. Eleven sovereigns outperformed

the index by more than five percentage points in total return, and 10 sovereigns underperformed the index by more than

five percentage points in total return (FIGURE 1). On an absolute basis, while “only” four countries generated negative returns

during this period, three of them fell sharply. Lebanon returned -10%, Argentina returned -37%, and Venezuela returned -57%.

Performance data for three years through September 30, 2019 paints a similar picture. In the past three years, the EMBIGD

returned 14.4%.1 Once again, the vast majority of sovereign debt delivered positive returns, but some countries much more

so than others. Seventeen sovereigns outperformed the index by more than 10 percentage points in total return (FIGURE 2).

And once again, on an absolute basis, Lebanon (-11%), Argentina (-46%), and Venezuela (-78%) fell precipitously.

1. Source: J.P. Morgan. As of September 30, 2019.

FIGURE 1: Country Excess Returns Relative to EM Sovereign Index (Year-to-Date)

FIGURE 2: Country Excess Returns Relative to EM Sovereign Index (3-Year)

SOURCE: J.P. Morgan. As of September 30, 2019.

SOURCE: J.P. Morgan. As of September 30, 2019.

20%

10%

0%

-10%

-20%

-30%

-40%

-50%

-60%

-70%

Ukr

ain

eSe

neg

alK

en

yaN

igeri

aE

cu

ado

rU

rug

uay

Kaz

akh

stan

Cô

te D

'Ivo

ire

Co

lom

bia

Co

sta

Ric

aJo

rdan

Pan

ama

Peru

Gh

ana

El S

alva

do

rJa

mai

ca

Eg

ypt

Ru

ssia

An

go

laIn

do

nesi

aP

arag

uay

Mexi

co

Ch

ileP

hili

pp

ines

Gab

on

Om

anE

MB

I IG

Beliz

eM

oza

mb

iqu

eG

uat

em

ala

Cam

ero

on

Bela

rus

Bra

zil

Eth

iop

iaT

rin

idad

& T

ob

ago

Bo

livia

Iraq

Ind

iaU

AE

Do

min

can

Rep

ub

licSo

uth

Afr

ica

Nam

ibia

Ro

man

iaE

MB

IGD

Aze

rbai

jan

Mo

rocco

Vie

tnam

Mal

aysi

aP

akis

tan

Bah

rain

Arm

en

iaH

on

du

ras

Sri L

anka

Tu

nis

iaP

apu

a N

ew

Gu

inea

EM

BIG

D H

YH

un

gar

yT

urk

ey

Mo

ng

olia

Ch

ina

Geo

rgia

Cro

atia

Po

lan

dSe

rbia

Taj

ikis

tan

Slo

vaki

aLi

thu

ania

Zam

bia

Suri

nam

eLe

ban

on

Arg

en

tina

Ven

ezu

ela

50%

30%

40%

20%

0%

-20%

-40%

-60%

-70%

-80%

10%

-10%

-30%

-50%

-90%

Iraq

Gh

ana

An

go

laB

eliz

e

EM

BIG

D H

YIn

dia

Sri L

anka

Serb

iaH

un

gar

yP

hili

pp

ines

EM

BIG

D

Mo

rocco

Gu

atem

ala

Tri

nid

ad &

To

bag

o

Mexi

co

Geo

rgia

Ind

on

esi

a

Vie

tnam

Bela

rus

Ru

ssia

Ch

ile

Par

agu

ay

Ho

nd

ura

s

Mo

zam

biq

ue

Eg

ypt

Bra

zil

Nig

eri

a

Cam

ero

on

Kaz

akh

stan

Jam

aica

Mo

ng

olia

Ecu

ado

r

Arg

en

tina

Cro

atia

Mal

aysi

a

Sou

th A

fric

a

Co

sta

Ric

a

EM

BI I

G

Do

min

can

Rep

ub

lic

Peru

Cô

te D

'Ivo

ire

Pan

ama

Co

lom

bia

Jord

an

Pak

ista

n

Sen

eg

al

Aze

rbai

jan

Uru

gu

ay

Arm

en

ia

El S

alva

do

r

Ken

ya

Eth

iop

ia

Gab

on

Ukr

ain

e

Leb

ano

nZ

amb

iaSl

ova

kia

Lith

uan

iaB

oliv

iaT

urk

ey

Po

lan

dT

un

isia

Om

anC

hin

aR

om

ania

Nam

ibia

Ven

ezu

ela

BARINGS INSIG HT S OC TOBER 2019 3

The moral of the story is simple yet powerful: country selection matters and matters a lot. Selecting

the right countries requires active management and an investment process that seeks to pick the right

apples, and avoid the bad apples in the basket. Similarly, a specific country’s sovereign debt should

never be bought just because it is in the index, or without a full understanding of the risks and whether

or not potential returns compensate for the risks. A remarkable—and unusual—feature of EM sovereign

debt performance over the past few years is that investment grade-rated sovereigns have delivered

higher returns than high yield-rated sovereigns. This is partly because of the longer-duration bonds

of the former, but it also highlights the importance of discriminating among countries, especially high

yield sovereigns.

A few selective comments on some of the best and worst performing countries:

Argentina has been one of the most difficult emerging market sovereigns to analyze and forecast in

recent years: President Mauricio Macri won a historic election in 2015, effectively ending Kirchnerism,

and embarked on a macroeconomic stabilization program with heavy reliance on market financing

and subsequently an IMF program. In the end, the pain of adjustment led to Argentina’s traditionally

populist electorate delivering an unexpected and heavy defeat to President Macri in the primary

elections this past August. Barings’ EMD sovereign strategies were moderately overweight going into

the primary elections, but have since moved Argentina to underweight.

Lebanon’s financial challenges, including a high fiscal deficit and high debt burden, have been

well-known for a long time, but the country’s repayment capacity has been supported by non-

resident (Lebanese) deposit inflows. The sustainability of these inflows, in our view, has always been

unforecastable and potentially reversible in response to challenging domestic and regional politics.

Barings’ EMD sovereign strategies have not had any exposure to Lebanon in recent years.

Venezuela’s financial challenges have also been well known for many years, yet its future has been

difficult to forecast and analyze without visibility on the potential timing and nature of a regime

change. Venezuela’s very sizable contribution to index returns for many years made it tempting to

invest in, especially before its sovereign default in early 2018. Over the years, Barings’ EMD sovereign

strategies have had very minimal exposure to Venezuela and have had zero exposure for the period 1.5

years before its default until the present time.

Several sub-investment grade EM countries generated meaningfully higher returns than the index in

2019 and in the past three years, but each one of them is a unique and complicated story that, in our

view, required in-depth analysis and high conviction to invest and stay invested in, even during periods

of volatility. Barings EMD sovereign strategies have had exposure to Ghana, Angola, Ecuador, Ukraine,

El Salvador, Armenia and Brazil, among the top performers, over the past three years.

In addition to choosing not to invest in several countries in the index, the Barings team has invested,

and exploited value, in several countries that are not in the index, among them Albania and Macedonia.

This points to the potential benefits of broadening the opportunity set beyond the index and selecting

the right opportunities rather than just those that happen to be in the index.

“A specific country’s sovereign debt should never be bought just because it is in the index, or without a full understanding of the risks and whether or not potential returns compensate for the risks”

BARINGS INSIG HT S OC TOBER 2019 4

Where do we go from here? Are there generalizations we can and should make about EM sovereign debt? Yes and no.

While EM Sovereign BBB spreads are near their tightest levels versus U.S. Treasuries in the last 10 years (FIGURE 3), we see

good value in several EM investment grade sovereigns, including Mexico, Colombia, Indonesia, Romania and Russia.

Conversely, the spread between high yield sovereigns and investment grade sovereigns—as measured by the difference

between the EMBIGD 75th percentile spread and EMBIGD 25th percentile spread—is approaching the widest level of its

decade-long range (FIGURE 4). Does that mean we should pile into high yield sovereigns?

Our answer is decidedly “no.” While our proprietary investment process and sovereign default probabilities indicate that

the spreads on most EM sovereigns (over)compensate for actual default risk, the margin of uncertainty for cumulative

probabilities of default over time varies from country to country, as does our conviction in the credit trend.

Hence, while we can comfortably speak to the potential benefits and high merits of investing in EMD, picking the right

countries and securities is everything, in our view.

FIGURE 3: EM Sovereign Spreads Near 10-Year Tights FIGURE 4: HY-IG Sovereign Spread Differential Near 10-Year Wide

400 bps

Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-18Jan-17 Jan-19

350 bps

300 bps

250 bps

200 bps

150 bps

100 bps

EMBIGD BBB spread (bp)

400 bps

Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-18Jan-17 Jan-19

350 bps

300 bps

250 bps

200 bps

150 bps

100 bps

EMBIGD 75th percentile spread to 25th percentile spread di�erence (bp)

SOURCE: J.P. Morgan. As of September 30, 2019. SOURCE: J.P. Morgan. As of September 30, 2019.

Cem KaracadagManaging Director

Cem Karacadag is Head of Barings’ Emerging Markets Sovereign Debt Group. Cem is the lead portfolio

manager for the Emerging Markets Sovereign Debt strategy and backup portfolio manager for the

firm’s Emerging Markets Local Debt strategy and Blended Total Return strategy. Cem has worked in the

industry since 1994 and his experience has encompassed sovereign credit analysis, macroeconomic

policy research and advice, and emerging markets fixed income strategy. Prior to joining the firm in

2014, Cem was at OppenheimerFunds, where he worked on sovereign hard currency and local currency

investments in Eastern Europe and Asia. Before Oppenheimer, he worked at Credit Suisse covering

emerging market sovereigns in Asia and Latin America, and at the International Monetary Fund, where

he focused on monetary policy instruments, exchange rate policy and bank restructuring in China,

Indonesia and Eastern Europe. He also held positions at Standard & Poor’s and the Federal Reserve

Bank of New York. Cem holds a B.A. in Economics from Tufts University and an M.A. in International

Economics and European Studies from Johns Hopkins University.

IMPORTANT INFORMATION

Any forecasts in this document are based upon Barings opinion of the market at the date of preparation and are subject

to change without notice, dependent upon many factors. Any prediction, projection or forecast is not necessarily

indicative of the future or likely performance. Investment involves risk. The value of any investments and any income

generated may go down as well as up and is not guaranteed by Barings or any other person. PAST PERFORMANCE IS

NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Any investment results, portfolio compositions and or examples

set forth in this document are provided for illustrative purposes only and are not indicative of any future investment

results, future portfolio composition or investments. The composition, size of, and risks associated with an investment

may differ substantially from any examples set forth in this document. No representation is made that an investment will

be profitable or will not incur losses. Where appropriate, changes in the currency exchange rates may affect the value

of investments. Prospective investors should read the offering documents, if applicable, for the details and specific risk

factors of any Fund/Strategy discussed in this document.

Barings is the brand name for the worldwide asset management and associated businesses of Barings LLC and its global

affiliates. Barings Securities LLC, Barings (U.K.) Limited, Barings Global Advisers Limited, Barings Australia Pty Ltd, Barings

Japan Limited, Barings Real Estate Advisers Europe Finance LLP, BREAE AIFM LLP, Baring Asset Management Limited,

Baring International Investment Limited, Baring Fund Managers Limited, Baring International Fund Managers (Ireland)

Limited, Baring Asset Management (Asia) Limited, Baring SICE (Taiwan) Limited, Baring Asset Management Switzerland

Sarl, and Baring Asset Management Korea Limited each are affiliated financial service companies owned by Barings LLC

(each, individually, an “Affiliate”).

NO OFFER: The document is for informational purposes only and is not an offer or solicitation for the purchase or sale

of any financial instrument or service in any jurisdiction. The material herein was prepared without any consideration of

the investment objectives, financial situation or particular needs of anyone who may receive it. This document is not, and

must not be treated as, investment advice, an investment recommendation, investment research, or a recommendation

about the suitability or appropriateness of any security, commodity, investment, or particular investment strategy, and

must not be construed as a projection or prediction.

Unless otherwise mentioned, the views contained in this document are those of Barings. These views are made in

good faith in relation to the facts known at the time of preparation and are subject to change without notice. Individual

portfolio management teams may hold different views than the views expressed herein and may make different

investment decisions for different clients. Parts of this document may be based on information received from sources we

believe to be reliable. Although every effort is taken to ensure that the information contained in this document is accurate,

Barings makes no representation or warranty, express or implied, regarding the accuracy, completeness or adequacy of

the information.

Any service, security, investment or product outlined in this document may not be suitable for a prospective investor or

available in their jurisdiction.

Copyright and Trademark

Copyright © 2019 Barings. Information in this document may be used for your own personal use, but may not be altered,

reproduced or distributed without Barings’ consent.

The BARINGS name and logo design are trademarks of Barings and are registered in U.S. Patent and Trademark Office and

in other countries around the world. All rights are reserved.

Barings is a $325+ billion* global financial services firm dedicated to meeting the evolving investment and

capital needs of our clients and customers. Through active asset management and direct origination, we provide

innovative solutions and access to differentiated opportunities across public and private capital markets.

A subsidiary of MassMutual, Barings maintains a strong global presence with business and investment

professionals located across North America, Europe and Asia Pacific.

*As of June 30, 2019

19-970221

LEARN MORE AT BARINGS.COM