Institutional investors are most worried about growth and a potential recession, while inflation is now less of a concern, said James Craige, co-chief investment officer and head of emerging markets at Stone Harbor Investment Partners, a global credit specialist with expertise in emerging and developed markets debt, in an interview.
"The growth concern — specifically the recession risk — is brought about by the softness in capital goods and manufacturing, the tightening of lending standards, the decline in money supply and the rise in global short rates," he said. "While a significant global recession is not our forecast, the fear of it will take a while to dissipate."
Given the firm's view that the economy is not facing a "significant global recession, but we are looking at subdued growth over the medium term," Mr. Craige thinks investing in yield is attractive.
"There has been an enormous amount of value created in fixed income — value we have not seen in some sectors in a couple of decades," he noted. Specifically, he is bullish on three sectors — some of which overlap:
- Debt from countries and corporations that should benefit from the recovery in China's growth. "We believe you should be investing in entities that sell to China," Mr. Craige said. Accordingly, he favors U.S. dollar-denominated debt from exporters in Latin America, Africa and parts of Asia.
- Debt from countries that have aggressively hiked policy rates and currently have high real rates and declining inflation. "Emerging markets countries started the hiking cycle earlier and were more aggressive than their developed market counterparts," he said. "This worked as inflation is slowing but leaves many countries with high real rates which should eventually decline. We favor local currency debt from Brazil, Mexico and South Africa."
- He also likes high-yield sovereign debt from emerging markets issuers as more than 85% of this segment is trading below par.
Mr. Craige also said that while interest rates have risen globally, they have stabilized recently. "We believe the Fed has moved to a less adversarial relationship with the market given the slowdown in growth data and the recent decline in inflation," he said. "This should eventually lead to a decline in fear and an increase in risk appetite. We have started to see some of this now with some sectors of the fixed-income market recovering substantially." He cited U.S. and European high yield as two areas where spreads have "tightened meaningfully," while global investment-grade corporates have also seen "a noticeable recovery."
While the traditional 60% equity/40% bond portfolio has come under criticism given how poorly both stocks and bonds performed last year, Mr. Craige counters that fixed income is now "very attractive" and that institutional investors should be increasing this allocation.
"The volatility (in bonds) is lower than (in) equities and given the move in rates, the total return prospects are as favorable as they have been in quite a while," he added. "We have seen this amount of value created — absolute yield — only a handful of times over the past couple of decades. From an asset allocation standpoint, fixed income can now provide the volatility-dampening characteristics people have used it for historically and provide the return as well."
Stone Harbor has $10.2 billion in assets under management.