JPM EMD chief backs HY sovereigns to beat investment grade

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EM high yield sovereign debt is poised to outperform investment grade bonds as it offers better valuations and fears over the sector's default risk have receded, according to JP Morgan Asset Management’s Pierre-Yves Bareau..

Speaking to Citywire Global, the group's head of emerging market fixed income said he has started to rotate out of long-term hard currency bonds into short-term high yield in his JP Morgan Emerging Markets Strategic Bond fund over the past month.

He has since built up some positions in countries such as Venezuela, Jamaica, Sri Lanka and Pakistan.

‘Within emerging market hard currency debt, sovereign high yielders will outperform investment grade bonds. Valuations for the latter are trading close to fair-value levels, which means that investors looking for higher yielding paper are increasingly turning towards HY sovereigns.’ he said.

Investors are also becoming more relaxed from a macro point of view, Bareau said.

'Sovereign risks in some of the more prominent EM high yield countries, such as  Argentina and Ukraine, have decreased, which means that investors are more prepared to invest in these issues than earlier this year.'

As he has grown more positive on the prospects of the hard currency EM debt sector, Bareau been increasing his exposure, adding 10% since the beginning of the year and bringing his total exposure to this sector to 35% of his portfolio.

‘We started to buy back after last year’s sell-off. The sector is still quite cheap and doesn’t present any risk on the supply side,’ he said.

Brazil and Russia

One of Bareau's favourite asset classes at the moment is Brazilian inflation-linked bonds, which he said are benefiting from high real rates while breakevens are very low.

‘Brazilian inflation-linked notes are low beta bonds, therefore good after a market rally as they have a solid defensive profile,’ he said.

Elsewhere in the fund, Bareau is long the Russian credit and short the rouble. ‘There is still value in Russian banks and steelmakers. We are short the rouble as we think the country will try to devaluate to regain some economic growth,’ he said.

Tapping China's potential

Although China still suffers strong headwinds from the property and shadow banking sectors, Bareau is bullish on its cyclical businesses.

The manager plays China indirectly, through a long position on the Malaysian ringgit. ‘We prefer to have exposure there as the currency will strongly benefit from exports to China and the US,’ he said.

Corporate picks

The Emerging Market Strategic Bond fund is also heavily invested in corporate bonds (28.5% of the portfolio).

In this area, Bareau favours companies based in Brazil (4.5%) and the United Arab Emirates (4%). ‘I like some banks in the UAE as they are in good financial shape and have a lot of cash,’ he said.

In Brazil, he holds the construction company Odebrecht as he said it will strongly benefit from the infrastructure programme launched by the government.

Bareau has returned 17.67% over the past three years, 2.76 percentage points more than the average manager in the bonds – EM global sector.