A Balanced Approach to EM Investing

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A blended EM Equity/EM Debt strategy is an attractive lower volatility alternative to a pure EM equity strategy, enabling investors to capture the bulk of the upside, while improving downside capture. Such a strategy enhances portfolio diversification, by providing exposure to a broader opportunity set, and allows investors to take advantage of the overall and country-specific economic cycles.

Emerging Markets (EM) equities have provided investors with years of significant upside, but risk-adjusted returns have underperformed other major global asset classes. One attractive way to access EM equity upside, while managing drawdown risk, is to invest in a blended strategy that incorporates both EM equities and EM fixed income, with allocations actively managed on a real-time basis, depending on the market cycle. We see this as a lower volatility alternative to a pure EM equity strategy, enabling investors to potentially capture the bulk of the upside, while reducing downside capture, with the debt component helping to dampen volatility and provide stable current income. In addition, incorporating EM debt can help to improve regional diversification, reducing the concentration of Asia and increasing the number of investible countries from 24 to approximately 80, and providing access to the entire capital structure for individual companies.

MSCI EM Regional Breakdown

Source: TCW Portfolio Analytics, February 28, 2019

50% MSCI EM / 50% EM Debt Regional Breakdown

Source: TCW Portfolio Analytics, February 28, 2019

For illustrative purposes, below we present a comparison of a simple 50/50 blend (“blend”) of the MSCI EM and the JP Morgan Emerging Markets Global Diversified (EMBI GD), the major dollar-denominated EM sovereign debt index, against the standalone EM equity and debt indices and the S&P. Not surprisingly, over the last 20 years, the MSCI EM posted the highest return for any single twelve month period (over 90%). Both the MSCI EM and the blend performed best during periods of rising growth. During periods of falling growth, however, the debt sleeve of the blend provided return protection; the worst rolling 12-month period for EM debt was approximately 20% versus 56% for EM equity. Notably, the blend’s highest and lowest 12 month rolling returns were both better than those of the S&P, which is typically a major holding in most global portfolios.

Best and Worst 12 Month Returns

Source: TCW Portfolio Analytics; Data as of February 28, 2019

Furthermore, over the past 20 years, the cumulative return on the 50/50 blend has exceeded the MSCI EM return by 46 basis points annualized, with a beta of 0.62. Put simply, the debt component has enhanced returns by tempering drawdowns and shortening drawdown recovery time.

Cumulative Returns

Source: TCW Portfolio Analytics; Data from February 28, 1999 - February 28, 2019

As such, Sharpe ratios are higher for the blend versus the MSCI EM over both short and longer time periods with an up capture of 62% and a downside capture of only 63%.

Source: TCW Portfolio Analytics

Implementation and Outlook

We believe the optimal blended strategy is one with the flexibility to actively adjust allocations between equity and debt, in order to capture market upcycles, while managing downside risk. At TCW, we have a long track record of managing EM blended strategies, through the TCW Worldwide Opportunities Strategy (launched 1987) and the TCW Emerging Markets Multi-Asset Opportunities Fund (launched 2013). Focusing on the best ideas in the emerging and frontier equity and debt markets, the strategy allows investors to potentially capture all stages of development in a particular country and shift capital structure positioning over time to reflect those segments with the most attractive risk adjusted return dynamics. Asset allocation decisions between equity and debt are driven by our views on economic growth, valuations and technicals. Generally, a strong growth environment, as well as a widening EM/ DM growth differential, favors the equity markets, while the debt markets provide better defensive trades in less robust environment. Local currency debt is something of a hybrid between the two – offering stable fixed income through coupon payments and beta to growth through FX appreciation potential.

We also see this as an interesting way for investors without any exposure to EM to more easily access both the equity and debt markets through a single vehicle. Emerging markets currently represent close to 60% of the global economy and an estimated 70.6% of 2019 global growth1 and benefit from strong demographics, a rising middle class, and a growing local investor base. Moreover, EM has grown to represent approximately 20% of global fixed income and over 25% of global equities, warranting a standalone allocation to the asset class.

We would be pleased to discuss this in more detail with you.

1 Source: IMF World Economic Outlook as of October 2018

 

LEGAL DISCLOSURES

GENERAL DISCLOSURE
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

STRATEGY DISCLOSURE
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. Any issuers or securities noted in this document are provided as illustrations or examples only, for the limited purpose of analyzing general market or economic conditions and may not form the basis for an investment decision, nor are they intended to serve as investment advice. Any such issuers or securities are under periodic review by the portfolio management group and are subject to change without notice. TCW makes no representation as to whether any security or issuer mentioned in this document is now in any TCW portfolio. TCW, its officers, directors, employees or clients may have positions in securities or investments mentioned in this publication, which are subject to change without notice. Any information and statistical data contained herein derived from third party sources are believed to be reliable, but TCW does not represent that they are accurate, and they should not be relied on as such or be the basis for an investment decision. All information is as of the date of this presentation unless otherwise indicated.

An investment in the strategy described herein has risks, including the risk of losing some or all of the invested capital. An investor should carefully consider the risks and suitability of an investment strategy based on their own investment objectives and financial position. There is no assurance that the investment objectives and/or trends will come to pass or be maintained. 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 herein. TCW assumes no duty to update any forward-looking statements or opinions in this document. This material comprises the assets under management of The TCW Group, Inc. and its subsidiaries, including TCW Investment Management Company LLC, TCW Asset Management Company LLC, and Metropolitan West Asset Management, LLC. Any opinions expressed herein are current only as of the time made and are subject to change without notice. The investment processes described herein are illustrative only and are subject to change. Past performance is no guarantee of future results.

FUND DISCLOSURE
This material is for general information purposes only. There can be no assurance that the objectives and/or trends will come to pass or be maintained. This material may include estimates, projections and other “forward-looking” statements. Actual events may differ substantially from those presented. TCW assumes no duty to update any such statements. Projections are based on current asset prices and are subject to change.

All information is as of the date of this presentation unless otherwise indicated.

The processes described herein are illustrative only and subject to adaptation in any particular context. This material reflects the current opinions of the author but not necessarily those of TCW and such opinions are subject to change without notice. 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.

INVESTMENT RISKS
Equity investments entail equity risk and price volatility risk. The value of stocks and other equity securities will change based on changes in a company’s financial condition and in overall market and economic conditions. Fixed income investments entail interest rate risk, the risk of issuer default, issuer credit risk, and price volatility risk. Funds investing in bonds can lose their value as interest rates rise and an investor can lose principal. Fund share prices and returns will fluctuate with market conditions, currencies, and the economic and political climates where the investments are made. Emerging markets securities carry special risks, such as less developed or less efficient trading markets, a lack of company information, and differing auditing and legal standards. The securities markets of emerging markets countries can be extremely volatile. The Fund’s investments denominated in foreign currencies will decline in value if the foreign currency declines in value relative to the U.S. dollar.

GLOSSARY OF TERMS
Basis Point –
One hundredth of one percent, used chiefly in expressing differences of interest rates. Beta – The sensitivity of a stock (portfolio) to the market (benchmark) in the capital asset pricing model. It is comprised of the volatility of a stock and its correlation with the market (benchmark). Capital Ratio – The ratio of a bank’s capital to its risk. Capital Structure – A capital structure is a mix of a company’s long-term debt, specific short term debt, common equity and preferred equity. The capital structure is how a firm finances its overall operations and growth by using different sources of funds. Defensive – Stock that provides a constant dividend and stable earnings regardless of the state of the overall stock market. Drawdown – A decline in an investment or fund. Emerging Market (EM) – A country that has some characteristics of a developed market but is not a developed market. This includes countries that may be developed markets in the future or were in the past. FX Foreign Exchanges – The exchange of one currency for another, or the conversion of one currency into another currency. Frontier Markets – Frontier markets are countries with investable stock markets that are less established than those in the emerging markets. JP Morgan EMBI Global Diversified Index (EMBI GD) – A market capitalization-weighted total return index of U.S. dollar and other currency denominated Brady bonds, loans, Eurobonds and local market debt instruments traded in emerging markets. MSCI – An investment research firm that provides indices, portfolio risk and performance analytics and governance tools to institutional investors and hedge funds. Risk-Adjusted Return – Refines an investment’s return by measuring how much risk is involved in producing that return, which is generally expressed as a number or rating. Rolling Returns – The annualized average return for a period ending with the listed year. Rolling returns are useful for examining the behavior of returns for holding periods similar to those actually experienced by investors. Sharpe Ratio – A riskadjusted measure calculated as the ratio of excess return to standard deviation. The Sharpe ratio determines reward per unit of risk. The higher the Sharpe ratio, the better the historical risk-adjusted performance. Technicals – Analyzing statistics generated by market activity, such as past prices and volume. Valuations – The process of determining the current worth of an asset or company. There are many techniques that can be used to determine value, some are subjective and others are objective. Volatility – A measure of the risk of price moves for a security calculated from the standard deviation of day-to-day logarithmic historical price changes.

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