At a time when even hedge fund managers are settling in for a prolonged period of sporadic, unpredictable growth, Kristin Ceva, senior vice president and director of emerging markets fixed income strategies at Payden & Rygel remains a maverick.
Ceva maintains that emerging markets will continue to deliver steady growth, primarily through government debt. The Los Angeles investment manager, which oversees a total of $54 billion in assets with about $800 million in emerging markets, has also seen its flagship Payden Emerging Markets Bond Fund deliver strong annualized returns of 14.5% since its launch in 1998.
Ceva recently spoke with Money Management Executive Editor Lee Barney about the corners of the globe where she sees the greatest promise.
Money Management Executive: When you begin putting together your portfolios, either for retail or separately managed accounts, where do you start?
Kristin Ceva: Looking at different countries around the world for the most attractive investing opportunities, we primarily focus on sovereign debt markets. But we also get involved in some corporate bonds, as well. Emerging market countries often issue dollar-pay bonds, which are called hard-currency bonds, although we also invest in local currency bonds.
MME: How many emerging markets products does Payden & Rygel offer?
Ceva: On the fixed-income side, we have the Payden Emerging Market Bond Fund, on the equity side we have a Metzler Payden European Emerging Markets Bond Fund. We have a joint venture with Metzler Bank through which we offer Metzler Payden funds.
And then we run separate account, institutional money in a number of different strategies. We use emerging markets in many of our global bond portfolios. We can use emerging markets in what we call our core plus strategies, in which you are using both high yield and emerging markets as your "plus" sectors to your "core" fixed income allocation.
And we also integrate emerging markets in both our low-duration and high-grade accounts, the latter of which are investment grade only, because among emerging market countries, there are many that are investment grade these days.
MME: While the emerging markets sector of the fixed income market has grown tremendously over the past decade, is its momentum dwindling?
Ceva: We would answer that it is not. Certainly, you are not going to see the same type of returns as you would in the past, but in emerging markets, it's not just the dollar-pay debt, because now you are also looking at local markets where you can earn additional yield. We are also looking at corporate rates earning additional yield, and we've also increased equities in our portfolios. Eastern European equities, for instance, have done extremely well.
Because of the improving fundamentals and improvement in economic and political reforms in these convergence plays, we believe ongoing changes in economic institutions will continue to propel emerging markets fixed income.
MME: What about regional unrest?
Ceva: If you look at some of what has sparked trauma or turbulence in emerging markets, it's often been political changes in administration. I think what Payden & Rygel looks at now is fission. We look at the strength of a country's political and economic institutions in order to determine how traumatic political events may become. Strong institutions, like being a member of the EU or NAFTA, or having independent or autonomous central banks, having gone through previous political transitions smoothly, or having gone through the process of privatization - all of these things make it more difficult now for a new administration or change in government to throw things off course or reverse things completely. So, we are not deterred. In fact, I see lots of opportunities still existing in emerging markets.
MME: Why do you like the macroeconomic situation in Russia when capitalism there has clearly failed to take off and many businesses continue to be corrupt?
Ceva: There definitely are reasons to be negative about Russia, but you have to look at Russia a little bit differently on the sovereign side. When I meant investing in government bonds versus the corporate or equity side, there's really a difference between the macro picture and the micro picture. On the macro side, you have continual upgrades from the rating agencies. Right now, Russia is a triple B minus equivalent across the board. It's been continually improving from single B back in 1998, and is expected to continue to improve, so it's an upgrade story.
Right now the big story of what you see in Russia is their ability and willingness to pay back debt. If you look at all their debt-to-GDP trends, those are rapidly improving because they keep paying back debt early. They are paying back debt early to the Paris Club, for instance. They've talked about paying back other types of external debt to other creditors. Those projections are set to keep falling, and so their credit ratios are going to improve quite a bit in terms of their debt loads. And that's the primary thing people look at in terms of ability to pay back debt.
They have a lot of hard currency, $150 billion in reserves, and they have an enormous current account surplus and an enormous fiscal current account surplus in the range of 11% of GDP. Those are outstanding credit indicators on the macro picture.
And they are doing the right thing in taking those oil windfalls they have earned from high oil prices and putting it in a rainy day fund, an oil stabilization fund, which they are currently using to pay down debt.
So, on the macro side it's very positive and you are going to continue to see the spreads, or the yields, on Russia compress. The spreads on bonds to Treasuries have come down quite a bit to approach that of Mexico, so they are trading about the same right now, about 150 to 160 spread to U.S. Treasury, down from about 240 in Russia at the start of this year. And I believe this strong spread compression in Russia will continue to narrow, and that flat trade with relation to Mexico - they used to trade wide - will probably now go through Mexico.
MME: And the micro picture?
Ceva: Because there are risks with regard to the region's very difficult and unpredictable business environment, we feel, on the micro side in Russia, quite a bit differently than we do on the macro side. While we are comfortable buying the sovereign bonds, we are much less comfortable buying the corporate bonds.
Also, there has been a slowdown in investment because of this unpredictable business environment, particularly after the Yukos situation, whereby the oil oligarch Mikhail Khordorkovsky was arrested and banished to a nine-year jail sentence in May for tax evasion and fraud. Following that, the business environment has really deteriorated in Russia, and that's caused investment to slow, impeding growth from where it really should be.
MME: Where do you see other interesting developments?
Ceva: In Latin America, we like a number of countries where we see good momentum and some positive outlook. Brazil, Peru and Panama are some of the countries I would highlight, along, again, with Mexcio. We really like the local markets there. We think you are earning at some attractive yields, and so we are buying the peso-denominated bonds.
MME: What about U.S. dollar-denominated versus local issues?
Ceva: As spreads on U.S. dollar-paid bonds have narrowed quite a bit over the past few years, many investors are now looking at local currencies and taking on that risk. Also, you are being paid a much higher yield to do that. We are targeting those countries where we see rates coming to the end of their hiking cycle, and where central banks and governments are starting to cut rates, and also where the currency has the potential to appreciate. That's another reason we really like Mexico, Brazil and Peru.
I'd add to that, Turkey and the Ukraine, the latter being an interesting example where we had a local T-bill trade starting in December as Victor Yushchenko, the new president in the Ukraine after the Orange Revolution, was coming into office. People were quite optimistic on what he could do in terms of reforms and looking westward instead of towards Russia. The yields on the Ukranian T-bills that we bought in December were at 12%, and they've already compressed to 6%, so that's been a very interesting investment, which I attribute to the positive political situation, and also because people expected there to be a change in the currency peg. The hryvnia has since been de-pegged, permitting the currency to appreciate.
MME: When you travel the world to "kick the tires" in these far regions of the globe, what do you look for and where do you go?
Ceva: As a large manager of $54 billion in fixed income that's also a large global manager, we have really great access. We talk to the decision-makers in the finance ministries and the central banks. We meet with local political consultants and economists and take part in local forums, which allow us to have some off-the-record discussions. We also go to the IMF and World Bank meetings every year.
When we were looking at Argentina just before it defaulted in 2001, for example, we met with the actual finance ministers and Domingo Cavallo, who was at the point of taking over as the economy minister. That allowed us to see firsthand a lot of the political volatility that was taking place, and it made us quite concerned. Being on the ground led to our decision to exit our Argentina positions entirely, and that was nine months before the country defaulted. I have a number of different people on the team who travel regularly to these countries, so we make sure to find lots of different venues.
MME: The Payden Emerging Markets Bond Fund returned 24.2% in the 12 months trailing June 30 and has an annualized return of 14.5% since inception in December 1998. Do you expect your fund to continue to do well, and, perhaps, might you concentrate holdings on convergence plays?
Ceva: Yes, we've returned about 24% over the past year, compared to the benchmark's 19%. We keep trying to find the next Ukraine, looking for the next opportunity. While we don't have a convergence fund, per se, we really like Eastern Europe. We think it's a region that has a lot of promise and great advantages in terms of taxes and skilled labor and the quality of education.
I think there's been a bit of a cloud over countries like Romania and Bulgaria in perception of their acceptance as EU member candidates because of the French no vote on the EU constitution. But I still believe both those countries will join the EU as planned. There's no direct link between the constitution and enlargement, and I think acceptance negotiations for Turkey will begin on Oct. 3. It's going to be a 10 to 15 year process for Turkey, but even if they are not a full member at the end of that time period, they're still going to have a closer working partnership with the EU.
MME: Since emerging markets are known to be volatile, how do you have the nerves to withstand this type of a long-term play?
Ceva: You are going to have countries defaulting or with problems, like Argentina, but the difference from past crises, such as the Mexico crisis in 1994 and the Russia crisis in 1998, is that at that time, when one country defaulted, the entire emerging market class was penalized. That is not the case today. Emerging markets are always going to face bouts of volatility, but if you've looked at those bouts of volatility over the past decade, you've always been rewarded to buy when things widen. That has been a structural, not a cyclical trend. High yield is cyclical; it's driven by default rates and business cycles, but if you look at the trends in emerging markets, it's much more structural in nature. Again, I don't think the spreads are going to revert to the mean of seven years ago, when things were significantly different on the fundamentals.
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