Market Sector Update

• The Fund's benchmark, the JP Morgan GBI-EM Global Diversified Index, posted gain of 4.4% in the first quarter in U.S. dollar terms, with about half coming from stronger currencies. Continued robust global and emerging-market economic data, positive investor sentiment and a weaker U.S. dollar were key macro drivers. This was despite a sharp rise in U.S. Treasury yields, a sell-off in global equities and the U.S. and China entering a trade war.
• South Africa was the star performed, up 13%, driven by fresh leadership under President Ramaphosa and his focus on turning the economy around. The country also cut interest rates by 25 basis points to a two-year low. Brazil was up 4.4% after interest rates were cut by another 25 basis points and S&P cut its credit rating to BB-.
• Mexico gained 11% after interest rates were hiked 25 basis points, but the key drivers were more benign expectations for NAFTA negotiations and a more investor-friendly tone from left-leaning presidential candidate Lopez Obrador.
• Russia gained 4.3% after interest rates had been cut by 50 basis points. Turkey declined 4.6%, with GDP growth of over 7% appearing to be at the expense of excessive government borrowing. Meanwhile, Moody’s downgraded the country to Ba2. Indonesia declined 1%, with interest-rate cuts in the country coming to an end.
• Malaysia gained 5.6%, helped by recent annual growth figures of 5.9%, the best in three years. Thailand was up 4.4%, with the central bank committed to low rates in the face of low inflation and early stage growth recovery.

Portfolio Strategy

• Overall, we remain cautiously overweight emerging-market currencies based on improving fundamentals, but underweight local rates. We expect to be overweight Asian currencies such as the Malaysian ringgit as growth and exports improve.
• In Latin America, as Brazil’s ex-president Lula can no longer run for the 2018 presidential election, we may turn more positive on the currency. Conversely, we remain cautious on those vulnerable currencies that are more linked to commodities, sluggish growth and political issues. A key example is South Africa, which could face another credit rating downgrade despite the leadership change.
• The Mexican peso is another concern against the backdrop of forthcoming elections, NAFTA negotiations and soft industrial production. However, any positive news could see a surprise turnaround. Russia is an exception, with a continued easing bias potentially presenting opportunities for us to move overweight local rates. Where permitted, we see opportunities in off-benchmark frontier markets from Nigeria, which is recovering from a very low base, to Egypt offering double-digit yields, a falling current account deficit and improving growth.

Outlook

• 2018 started with a positive tone for global markets, but the picture has started to look less rosy. The key drivers are a fresh trade war between China and the U.S., a risk-off scenario in global equity markets, upside risks to U.S. Federal Reserve rate hikes and some signs that improvements in global and emerging-market growth may be moderating.
• Inflation is on target for most emerging-market countries and the normalisation in interest rates in developed economies continues to be slow and steady to prevent any disruption of financial markets. However, U.S. Treasury yields may rise faster than expected, and this could result in pressure on local bond prices. Furthermore, we believe around half of emerging-market central banks may turn hawkish in 2018.
• As a result, we view local rates with caution. Given the strong run for emerging-market currencies, we are considering when we may reach the top of this cycle and see at least a temporary pull-back. Nevertheless, growth is the key theme for 2018, and it should continue to be positive for emerging-market currencies, which remain undervalued in our opinion.
• As a region, Asia is more manufacturing-export-driven and benefits from low oil prices, which could help it outperform on the currency front in 2018. Moreover, demand for fixed income remains robust and an investment-grade government bond asset class yielding 6% remains compelling.

The opinions expressed are those of the Fund’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through March 31, 2018, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon. Past performance is not a guarantee of future results.

The JP Morgan GBI-EM Global Diversified is an unmanaged index that tracks the performance of emerging market debt. It is not possible to invest directly in an index.

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