- The significant repricing of EMD risk last year provides a pronounced opportunity for attractive forward-looking total returns.
- Even in an environment where interest rates plateau and dip over the next year, money market funds will continue to offer attractive yields compared to recent history.
- Federated Hermes real estate debt strategy seeks to deliver a return that remains stable throughout the cycle and is uncorrelated to other asset classes.
In a presentation on emerging market debt (EMD), Mohammed Elmi, Senior Portfolio Manager, and Ihab Salib, Head of International Fixed Income Group, looked at the prospects for the asset class following a difficult 2022.
“Last year we had a confluence of issues – such as the Russia-Ukraine war, the zero-Covid restrictions in China, and restrictive global monetary policy – which really hit performance in the emerging market hard-currency space,” said Elmi. “But we have recovered some of the ground that we lost last year and year to date, EM sovereigns, EM local markets and EM corporates have delivered a positive total return.”
“The significant repricing of EMD risk last year provides a pronounced opportunity for attractive forward-looking total returns,” said Elmi, citing exposure to commodities, technology, manufacturing, services, and positive demographics that can be found in emerging markets. Countries like Taiwan (the world’s leading manufacturer of semiconductors), Peru (which has 10% of the world’s copper reserves) and Ghana (which harvests 25% of the world’s cocoa supply)1, offer access to key trends in global business, Elmi added.
Figure 1: EMD provides access to key trends in global commerce
Federated Hermes EMD funds use a proprietary screening methodology to assess environmental, social, and corporate governance (ESG) risks in emerging markets debt. “The majority of EMD players rely on third-party providers to determine ESG factors and provide data. We don’t do that. All our research – whether on the credit side or integrating ESG in a credit process – is done in-house,” said Salib.
Will liquidity inflows continue?
In a breakout session on the latest trends in liquidity and money markets, Deborah Cunningham, Chief Investment Officer Global Money Markets, and Gary Skedge, Head of UK Cash Management Team, discussed the prospects for the asset class in the coming months.
Money market funds typically hold short-dated assets, particularly government and high-quality corporate debt, and have seen inflows of more than $1tn since January2 as rising rates have lifted the available yields on money market funds to their highest level in years. But as central banks approach the end of their hiking cycles and rate cuts loom into view the asset class could potentially lose some of its momentum.
“Even in an environment where interest rates plateau – and may go down in the second half of 2024 – we expect that some of that operating cash will move into micro and ultra-short duration as institutional investors adjust their risk balance,” Cunningham said, adding that many investors will continue to seek exposure to the money market yield curve and capital preservation. “In an environment where inflation comes close to the US Federal Reserve’s target of around 2-3%, you are still looking at yields of 3-4%, which is vastly different than the 0% environment that we have been operating in the long period prior to that.”
Why private credit?
In a discussion on private markets as a mainstream alternative, Patrick Marshall, Head of Private Credit, talked with Laura Vaughan, Head of Direct Lending, and Vincent Nobel, Head of Asset-Based Lending, about their strategies.
The Federated Hermes direct lending strategy is focused on the northern European lower mid-market senior secured segment of the market, because it can offer solid returns, less downside risk and one of the best legal environments to negotiate any restructurings, Vaughan said.
“The types of businesses we lend to are often quite boring with stable, predictable cash flows and provide convincing evidence on how they’re going to repay the loans. We operate at the conservative low risk segment of the market, with an emphasis on capital preservation and delivering consistent cash yields to investors,” she said. Key to the strategy are the origination agreements, Vaughan added. “We have signed binding origination agreements with top-tier banks in our target geographies: the Nordics, Benelux, Germany, the UK and Ireland. We are incredibly selective and are careful to choose the best loans for our investors.”
We aim to deliver a return that’s stable and uncorrelated to other asset classes.
Nobel was keen to point out that an allocation to real estate debt – which seeks to deliver income by making loans secured on commercial real estate – as part of a wider property investment strategy can help reduce the impact of real estate yield widening on overall portfolio return, while at the same time still maintaining exposure to the income that real estate assets generate.
“We aim to deliver a return that’s stable and uncorrelated to other asset classes. It’s a fundamentally defensive strategy. It means that when markets become more volatile – as we’ve seen in the last 18 months with rates going up – you can maintain great returns in some segments. We seek exposure to income which remains stable throughout the cycle, and we do that by finding good assets with good sponsors. Of course, markets can go through upheaval causing capital values to become more volatile, but we have significant protection against that. We continue to deliver,” Nobel said.
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1 Federated Hermes analysis
2 Money market funds spring a leak after year of record inflows
