December Emerging Markets Debt Update

Monthly Commentary

January 19, 2017

Emerging Markets Debt (EMD) partially retraced post-election losses in December, led by local currency debt, which had been most adversely impacted in November. Emerging Markets (EM) local currency debt returned 1.87% in December, bringing full year returns to 9.94% for 2016. On the external side, EM sovereign dollar debt outperformed corporates returning 1.33% and 0.78% respectively in December and for the full year of 2016, 10.15% vs. 9.65%. Net portfolio flows to dedicated EMD mutual funds in December were a negative $5.11 billion (a slower pace of net outflow than November), with outflows across hard and local currency funds and inflows into blended funds. New issuance in December totaled $17.84 billion with the majority issued by corporates.

Total Returns Across Asset Classes YTD 2016

Source: Bloomberg; JP Morgan; Data as of December 30, 2016

Looking at the Individual Asset Classes:

Sovereign Dollar Debt

EM sovereign debt returns this month were primarily driven by spread tightening, as U.S. rates continued to sell-off/steepen in December. Spreads tightened by approximately 20bps during the month and ended the year at 342bps, nearly 75 bps tighter than at the start of 2016.

Sovereign dollar debt finished 2016 as the best performing of the three EMD asset classes, led by lower-quality commodityexporters like Venezuela, Ecuador, and Zambia. Venezuela was the best performing country in the index in December and for the year, returning 7.9% and 53.2%, respectively, during these periods. Ecuador and Zambia were also among the best performers in December and returned 41.2% and 35.8%, respectively, for the year. These sovereigns were among the worst performing early in the year as oil and copper prices bottomed in January but benefitted from a rebound in commodity prices for the balance of the year.

On the other hand, Mozambique was the worst performing credit in December (-4.5%) as well as for the full year (-11.0%) after Belize. Along with Turkey, which lost its investment grade rating midway through the year, these were the only countries out of the 65 in the index to post negative returns for the year.


EM dollar corporate spreads tightened by 8 basis points in December, ending 2016 at 314bps, 114bps tighter than at the start of the year. Metals & Mining was the best performing sector for the year, returning 30.8%, as the price of primary metals recovered 30% in aggregate from the low in January1. The Oil & Gas sector similarly posted strong returns of 14.0% for the year as the price of oil ended nearly 20% higher from the start of the year and more than 50% from its January low2.

Defensive sectors – particularly Diversified, the highest rated (BBB+) sector in the index – underperformed during 2016 and were the worst performers for the month of December as well. The combined profile of short duration and high credit quality lagged during the year as the U.S. treasury curve bull flattened through the first three quarters and investors rotated into lower quality names in search of yield. In addition to the Diversified sector, which returned 4.17% for the full year, Real Estate and Financials underperformed for similar reasons, returning 6.34% and 6.55%, respectively, in 2016. It is worth noting that these were the three best performing sectors in 2015 and were priced tightly heading into 2016, with little room for additional capital appreciation.

EM corporate default rates ended 2016 at 5.1%, which is the highest annual default rate for the asset class since 2009 and compares to a 3.9% default rate for U.S. HY companies. That said, 2016 likely marked the peak of the EM corporate credit cycle. There are clear signs that corporate credit fundamentals are already improving – better economic growth momentum, stronger commodity markets and balance sheet deleveraging – and we expect these improvements to carry over into 2017. In fact, consensus estimates expect EM corporate default rates to fall to 2.1% in 2017, while U.S. HY default rates are expected to end 2017 at 2.5%.

Local Currency Debt

Emerging markets local currency debt partially retraced postelection losses, returning 1.87% in December. While the dollar continued to strengthen on expectations of increased fiscal spending and pro-growth policies in the U.S., this was primarily against G10 currencies. In fact, EMFX net appreciated versus the dollar during the month. Returns were certainly differentiated, with Russia and Brazil the top performers and Turkey and Romania, the worst. Brazil (57.8%) and Russia (37.5%), along with South Africa (30.8%), were the best performing countries for the year, posting double digit gains in both rates and FX. The worst performers were Mexico, given its sensitivity to U.S. trade policy, and Turkey, which saw a spike in political risk premium.


Net portfolio flows to dedicated EMD mutual funds in December totaled negative $5.11 billion (a slower pace than November), with outflows across hard and local currency funds and inflows into blended funds. Yet, despite outflows in the final two months of the year, portfolio flows for the year were strong, particularly for hard currency, which received $17.74 billion of the $23.07 billion that flowed into the asset class in 2016.

Weekly EM Dedicated Bond Fund Flows (USD Millions)

Source: EPFR Global, Citi Research

New Issuance

The issuance market slowed into the end of year, and December marked the low for the year, with $17.8 billion of gross supply and $5.2 billion net. The majority of new supply in the month came from corporates and regionally, from Asia. For the year, EM gross issuance totaled $467.6 billion – $144.9 billion of sovereign and $322.5 billion of corporate. Net supply totaled $157.4 billion as a large number of first time sovereign issuers came to the market in significant size.

Source: TCW calculations based on data provided by Bank of America Merrill Lynch & JPMorgan

Additional Fundamental and Valuation Charts

Signs of an EM Growth Pickup With the EM/DM Growth Differential Widening

Source: TCW Emerging Markets Research; Data as of December 30, 2016

Nearly 60% of Global Fixed Income Yields 2% or Lower

Source: Standard Chartered; Data as of January 3, 2017

Current Account Balances have Improved

Source: Morgan Stanley; Data as of September 30, 2016

Emerging Markets Index Valuations

Source: Bloomberg and JP Morgan

1 Metals price based on the London Metals Exchange Index. Low of 2049.0 on January 12, 2016 and close of 2659.6 on December 30, 2016. Source: Bloomberg.

2 WTI price based on West Texas Intermediate active contract price (Feb 2017). Low of $35.73 on January 20, 2016 and close of $53.72 on December 30, 2016. Source: Bloomberg.

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This material is for general information purposes only and does not constitute an offer to sell, or a solicitation of an offer to buy, any security. TCW, its officers, directors, employees or clients may have positions in securities or investments mentioned in this publication, which positions may change at any time, without notice. While the information and statistical data contained herein are based on sources believed to be reliable, we do not represent that it is accurate and should not be relied on as such or be the basis for an investment decision. The information contained herein may include preliminary information and/or "forward-looking statements." Due to numerous factors, actual events may differ substantially from those presented. TCW assumes no duty to update any forward-looking statements or opinions in this document. Any opinions expressed herein are current only as of the time made and are subject to change without notice. Past performance is no guarantee of future results. © 2019 TCW