Market Sector Update

• The Fund's benchmark, the JP Morgan GBI-EM Global Diversified Index, returned -6.68% in U.S. dollar terms over the quarter. Returns were negative across all regions, with Latin America being the main laggard, returning -10.07% over the period, whilst Turkey was the key detractor at a country level, returning -20% as the unexpected firing of the Central Bank governor renewed concerns over the country’s ability to deliver on effective monetary policy.
• The volatility we saw in emerging markets (EM) over the quarter originated in January following the surprise Democratic “blue wave” win, which led to a substantial repricing of the outlook for U.S. growth, indicated by a stronger and more coordinated stance on U.S. fiscal policy.
• Since this point, we saw 10-year U.S.Treasury yields increase by over 0.8% at the highest point and a rise in inflation expectations, which has led to increased focus on monetary policy across EM and whether a normalization cycle is in sight. We have already seen evidence of this in Brazil, Russia and Turkey, where rate hikes were above market expectations.
• The resultant macro backdrop has increased risk premiums in EM debt despite a number of positive developments we have seen over the quarter, including vaccine rollout momentum, a bounce-back in Chinese growth and higher commodity prices, providing a boost for EM exporters that suffered during the lockdown periods over the last year.

Portfolio Strategy

• The Fund outperformed the index over the quarter. Active positioning in local rates and currencies detracted from performance over the period. The short position in U.S. Treasuries was the main contributor to performance due to the sell-off that was experienced over the quarter.
• In local rates, underweight positions in Central and Eastern Europe names, such as Hungary and Poland, were positive for performance as inflation in the region remained elevated, making the bonds more susceptible to volatile moves in global rates. The move to an underweight position in Turkey at the start of March also added to performance as the bonds sold-off significantly following the removal of the Central Bank governor towards the end of the quarter.
• The overweight to Indonesia detracted as domestic demand continued to drag on growth and the government was forced to increase the recovery budget again. The overweight to South Africa also detracted as growth expectations began to appear overinflated given the country’s fiscal issues and large budget deficit.
• In currencies, the overweight to the Brazilian real detracted as volatility persisted due to the country’s fiscal uncertainty. The overweight to the Mexican peso also detracted due to initial signs of a strengthening U.S. dollar. The move underweight in Turkish lira was positive for performance as outflows put increased pressure on the currency.
• The quarter saw portfolio duration move from an initial net overweight in January - driven by longs in Russia, Mexico, South Africa, Indonesia and China - to a net duration underweight as the reflationary environment in developed and EM favored such positioning adjustments. Consistent with the prior quarter, Hungary and Poland remained core conviction underweights, while the change in net duration came from a sizeable short position in U.S. Treasuries.

Outlook

• Compared to the start of the year, the outlook for EM markets is now less certain due to the conflicting factors of improving global growth being supportive for risk assets and rising rates dampening returns on EM assets. Rising rates will be a key focus moving into the second quarter, with both a U.S. curve steepening and EM policy shifts coming into play.
• Monetary policy in EM is at an inflection point; central banks maintained easy monetary policy for the majority of last year, but we now expect focus to shift to when and how much central banks will hike rates. That being said, differentiation in EM will persist depending on a country’s inflation pressures, fiscal policy, and external accounts, and there will be a number of countries that will be able to maintain their dovish stance for the remainder of the year.
• We believe the outlook for growth in EM will be increasingly dependent on containment of the pandemic, as we have seen resurgences in certain countries over recent weeks, as well as the success of the vaccine rollout. Industry-led growth is likely to remain a key area of strength for EM, but a rise in cases could put this at risk, especially in the service sector. Again, we expect a degree of differentiation in EM with regard to growth, with cyclically sensitive EM assets being supported by the ongoing manufacturing and commodity rebound.

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, 2021, 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.

All information is based on Class I shares.

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