Stewart McAndie: Good morning and good afternoon. I'm Stewart McAndie, a member of the Ashmore UK Client Team. Welcome everyone, and thank you for joining today's Ashmore webinar: "Taming the Frontier: Outperformance and Risk Mitigation in Emerging Market Frontier Debt Markets." Today's webinar is for investment professionals only and not for members of the media. Any questions we do not answer live, we'll follow up post the webinar. 

Today, we're joined by Alexis de Mones, a Portfolio Manager in the Ashmore Emerging Market Debt Team. And Gustavo Medeiros, Ashmore's Global Head of Research, who I'll hand over to now first to set the scene and ask the first questions. Over to you, Gustavo.

Gustavo Medeiros: Thank you very much Stewart, for the introduction. I'm going to be brief in my intro. But as you all know and been talking about, we've been talking about it for a while, but emerging market (EM_ debt has been a quite resilient asset class within the last three years. If you look under the hood, you can see the contours of a new bull market quite clearly. EM sovereign high yield has been outperforming US high yield over the last two years by more than 15 percentage points. And US corporate high yield also underperformed EM corporate high yield. In the investment grade (IG) space now, EM local currency bonds are the best performing asset class within the last two years, above EM sovereign and corporate IG. But also above the Global WAG, which is a benchmark that has non-dollar assets as well. 

Year to date, the weakening dollar trend has been the key contributor to the EM performance obviously. But, again, the asset class resilience dates back to 2022, and has been largely underpinned by structural reforms post-pandemic that allowed for better gross domestic product (GDP) growth environments and better macro equilibrium. We're going to be talking a little bit about that across different countries in more detail.

The most significant transformation obviously occurred in the frontier space, where several smaller economies that had found themselves over-indebted during the pandemic had to undertake quite serious structural reforms, in some cases, alongside debt restructurings. These reforms are the genesis for the frontier debt improvement. So while there are very few distressed stories left, the asset class now has excellent investment opportunities considering both the level of returns offered by dollar and local currency bonds, and the improved fundamentals. Alexis, can you give us a sense of the recent performance across the both local currency and dollar-denominated frontier debt?

Alexis de Mones: Thank you, Gus. So when we talk about performance, we have to split it a little bit between external debt and local currency. So in external debt, the proxy market performance index is the JPMorgan NEXTGEN index, which is up 7% year to date, a little bit above the high yield portion of the MBGD. So, strong performance in the context of global fixed income products. A large dispersion of returns within that space. We have Lebanon up 50% year to date, Ecuador up 30% following an election there. And the likes of Ghana and other sub-Saharan African countries up, let's say, 12 to 15%. That's on the external debt space. 

In the local currency debt space, which has received a lot more interest from investors in frontier over the last two years, the returns have been higher. And here, there's no widely recognised or used index, but we have a proxy index that we track, where we have 27 issuers that have returned about 11.5% year to date. The return will depend how much duration you're willing to take in your local currency debt allocation, if you like. But 11 to 11.5% involves some duration risk taking. And the better performance in that space have been far and away Ghana up 50%, Zambia up 31%. So here sub-Saharan Africa, following devaluations in the last couple of years, have definitely shone and outperformed the rest of the universe. 

Performance has been strong, but what I want to say is that the yields remain attractive. We'll talk a little bit more about that. So NEXTGEN, the external debt proxy index, still has a yield that just bounced back up above 10%, as a matter of fact. In the local currency space, our own proxy index has a yield of 12.4%. Our own allocation in the fund is quite a bit higher than that. So it really depends, how you want to play that, and how concentrated you want to be in that space. So, Gus, so that's the intro on recent performance. I think we should talk a little bit about the market development. How has the asset class managed in the bout of volatility and the ructions of global rates and tariff wars?

Gustavo Medeiros: I think there has been very little volatility in general over the last six months or so, or year to date. There was a little bout of volatility right after the "Liberation Day", when US President Donald Trump announced very large tariffs in April. But within a couple of weeks, the market started looking through that as we started getting signals that it was preamble for a trade deal. As a matter of fact, we're just getting some headlines now. Trump has just tweeted about a deal with Vietnam, whereby Vietnam would agree to pay 20% tariffs on imports and 40% tariffs on trans shipment, whatever you think is the definition of trans shipment. There is going to be some uncertainty regarding to that. Overall, quite a tough position to be. 

But I would say that most of the frontier space is relatively insulated from that due to the fact that their economies have very little linkages with the US. Vietnam is perhaps the most notable exception within the frontier space. Obviously, most of Africa, Latin America, it's not the case. Central America does have some vulnerabilities, but they don't seem to be the focus on the trade war in that space, right? Again, overall I think the main trends that we highlight, obviously the weaker dollar, and thus better global liquidity have been the key factors driving good performance both in local currency assets and in high yield assets. Obviously, the local currency frontier benefits from both of those. But importantly, it's happening against the backdrop of key reform stories. It's worthwhile highlighting, again, as I mentioned at the beginning, how these countries have been already outperforming over the last two years, before the dollar was weakening or into these strong economic reforms. Back then, quite a lot were going from distress to regaining market access. But as you pointed out, Alexis, given the interesting level of yields, that was important. What we're seeing that is going to be another trend, what we're seeing now over the last six to 12 months has been also a strong disinflationary trend across all these countries. Many of these structural reforms came together with overhaul on foreign exchange (FX) regimes and monetary policy regimes. And that meant that we had a large one-off FX depreciation across many of these countries that led to very strong inflationary pressures. So this was countered by very tight monetary and fiscal consolidation, which is now allowing for some softening of growth, albeit growth remains at relatively high levels, which we’ll talk abouts later.

But also some pretty strong disinflation across many countries, in particular in sub-Saharan African countries where inflation has more than halved in several places. And, again, these countries in general are much less susceptible to the main macro risks, in particular tariffs. And any change at the marginal rates, I would say if US Treasuries sell off by 30-50 basis points, that's not going to make a big difference. But obviously if Treasuries widen by a much larger magnitude and liquidity tightens as a result of that significantly, that could be the headwind. But I would say that the tailwind, if the US Federal Reserve (Fed) is allowed to cut policy rates due to economic fundamentals, would be much stronger given where we are right now. 

Alexis, I think when I speak about frontier with investors, I get a lot of curiosity. And people are a little bit confused about the nature of the asset class. Can you walk us through the universe and the opportunity set? And why did we decide to launch a product that has flexibility to invest across both dollar assets and local currency bond assets in the space?

Alexis de Mones: In terms of the universe, on the hard currency side, really it overlaps very much with a high yield part of the MBGD. Part of our hard currency universe. And in our own definition of what constitute eligible investment for frontier, we have 45 credits in the sovereign debt space. We closely track 27 local currency markets where we believe we have the liquidity, the availability of both rates and FX instruments that we need to implement strategies in the local currency and FX space. And there is overlap between external debt and local currency, evidently. But this gives you an idea of the list of countries, the diversity of exposure you can achieve in the space. 

The universe is large in terms of size as well, we are talking about USD 200, actually USD 300bn of face value of external debt. And in terms of local currency debt instruments in that universe, we're talking about north of USD 700bn worth of instruments, excluding the pure FX instruments, like FX fours in India. So a lot you can do there, but obviously you have a tail of countries where those instruments don't trade in very large volumes. So you obviously have to diversify your position. But as a whole, it is already a pretty established asset class both in hard and in local currency space. And we know you have more entrants in the space, as a matter of fact.

In terms of the characteristics, one thing that is really interesting and really sets it apart from our traditional EM debt product is that in frontier, the local currency part of the market has a higher yield than the external debt part of the market. Usually you have the opposite. Usually the MBGD yield would be higher than the GBIM yield, but in the frontier it's different. And we covered that already with the local frontier, that universe yielding north of 12% as I explained. And what is interesting as well is the volatility. So, in the traditional EM debt space, you have the volatility if the local currency debt space is greater than the volatility of the hard currency space. But in frontier, because I estimate close to two third of the universe is really in countries that have either a peg or a soft peg or a managed FX regime. You have two-thirds of the universe where the currency volatility is really suppressed. 

Also, because the duration is quite a bit lower than in the broader set of local currency markets, then the volatility of your local currency frontier is between 4.5 to 6.5% if you have a diversified basket. So, that's quite a bit less than the high yield sovereign market which is, 12 to 13% volatility. So local is really the less volatile and high yielding part of the market, which explains, at least at the moment, the huge interest in that market, the great Sharpe ratio you can achieve in that space. I think that really characterises the two sides of the frontier debt space.

There is another big difference, which is that the high yield sovereign part trades on spread. The spreads are mean reverting, but quite volatile. So the NEXTGEN spread, for instance, goes anywhere from 400 basis points to 1,000 basis points over the cycle. So you do have cyclicality and volatility in your dollar part of the universe. And you have, as we explained, yield and low volume local currency. So when spreads are tight, it can be opportune to go higher in the local currency in terms of allocation. So you can definitely generate value by allocating across teams like that. And at the minute, the NEXTGEN spreads are close to 700 basis points. So not all-time wides, so not all-time tights either. But certainly we've gone a little bit down in risk in the dollar part of our portfolio recently as a reflection of how much some of those spreads are valued. And we've taken more opportunities in the local currency space.

Gustavo Medeiros: I think one of the interesting elements as well that it's worthwhile highlighting, which you alluded to already is the fact that these currencies are quasi-pegged, as you mentioned right after devaluation or they're in a much more stable regime. But occasionally, what we see is that there's a lot of reluctance once the external imbalances starts to build up, which we're very, very far away from that now. 

But say if in two years’ time, countries don't follow through with their structural reforms and the currency starts looking under or overvalued, you can see that in advance on the deterioration of the current account deficit, on the nervousness of the locals that start getting outflows, etc. That is an opportunity obviously to switch from local currency to the hard currency, particularly the front end of the curve where the bonds are much less volatile, which trades with the ability of servicing the debt. That's why I think there is a very strong appeal to have blended debt product where you have agnostic across. Where to invest, we're focusing on maximising returns vis-a-vis volatility, right?

Alexis de Mones: Good point, and typically what you can do as well, is you see those expectations of devaluation risk priced into the forwards, right, and the non-deliverable forwards (NDFs). So you keep your NDF positions relatively short maturity, and then when the implieds actually explodes up, then you may have opportunities to seek exposure while being paid to take the risk of devaluation. So certainly, that's a classic trade. I think Argentina has been a classic trade in that particular space, and more recently in terms of carry trade of that nature. So Egypt has also been one of the market's favourites, where you had quite a bit of devaluation risk priced into the forward, while the spot was officially compressed and quasi-pegged at 50 pounds to the dollar. So yeah, these are the carry positions, and how you can manage the risk of devaluation around those. So these are the management techniques we can apply to managing a frontier debt product.

Obviously, we look at the fundamentals in detail. Gus, you look at debt from a global macro perspective, you look at debt from a country bottom up perspective. What do you think are the most salient points in terms of macro performance, or changes in macro performance in the frontier space particularly?

Gustavo Medeiros: Well, I think it's quite clear that the balance between growth and inflation has improved significantly. We had, as I mentioned, massive inflationary pressures about 12 to 18 months ago. That's started to wane now as countries tighten monetary and fiscal policy. GDP growth has been on a much better footing post International Monetary Fund (IMF) deals and structural reforms. And even though we're seeing some softening post-tightening, it remains in a pretty good space. 

Overall, obviously the weakening dollar and better harvest across many frontier economies including, but in particular in sub-Saharan Africa, have been supporting disinflation in the short term. And we think that those remain pretty good drivers. Now, where we keep a very close eye to because frontier has, you know, a lot of frontier countries have been posting pretty good growth. But very, very quickly, you start seeing that becoming quite imbalanced as, you know, external accounts start deteriorating the fiscal. Quite a lot of the times, the growth has been driven by a fiscal bonanza. And that's very, very far from what we're seeing at the moment. 

So, despite better growth momentum, it's very hard to find large external imbalances across the frontier space today, largely thanks to the FX valuation and the very strong tightening on fiscal and monetary policy. The more transparent currency regimes also have been allowing FX reserves to improve meaningfully as investors get more confident. So a couple of examples, Ghana moves from a current account deficit of close to 3% in 2021 to an estimated 4% surplus this year. And in the meantime, the FX reserves surged from USD 5bn in late 2023 to around USD 11.7bn, as of the last print. Zambia's current account moved from a 3% deficit in 2023 to a 3% surplus estimated this year with FX reserves tripling from less than USD 1.5bn to now USD 4.5bn. Obviously these countries have benefited from positive terms of trade shock, in the case of Ghana in particular, very high gold prices. But Zambia actually have been navigating a very challenging macro backdrop with a very strong drought leading to shortages of energy. And yet they managed to increase copper output. It had, I would say, a marginal positive terms of trade shock. And that's very much a result of the structural reforms they've implemented, overhauling the environment for investment in the mining industry. 

So, the hard work on fiscal adjustments, the substantial improvements in primary balances across the board. If you look at the overall balance, in some places, particularly in Africa, it's harder to see that because, again, the very high level of interest rates has been leading to higher interest cost. But the underlying finances have improved significantly. I think the best example of improvement in the finances has been obviously Argentina, which moved from a budget deficit of slightly more than 5% in 2023 to a budget surplus of 2% in 2024. And now they have been increasing their primary budget surpluses to generate ongoing nominal balanced accounts, balanced fiscal accounts. And despite that, GDP growth actually didn't do that poorly. In 2023, when they had a budget deficit of close to 5.5%, GDP declined by 1.9%. It contracted another 1.3% in 2024 amidst the fiscal consolidation. But now growth is surging above five, to more than 5% this year. So this V-shaped recovery highlights how once you do structural reforms, better capital allocation, and better investment flow into the country, particularly on the foreign direct investment (FDI) space, can allow for a rebound of growth. 

Obviously, you cannot talk about improvement in the frontier space without talking about the IMF funding. So market access is really important for these countries. And the big problem during the pandemic was not only that these countries were over-indebted and imbalanced in many cases. But also obviously, because of the pandemic, amidst these macro imbalances, they lost market access. The IMF was initially a bit slow to react to that, but by 2022, it has largely caught up, and announced very large programmes with a number of countries, including the likes of Zambia and Ghana, which followed debt restructuring. But also with countries like Egypt and Pakistan that managed to go through the balance of payment crisis without a debt restructuring. Some countries still did not require an IMF assistance, like Nigeria and Angola ,for example. Where Angola had graduated from an early programme and they're not in a programme at the moment. But the IMF is always saying it is open for transactions. It's not all, positive, obviously. There are challenges in programmes of countries like Ecuador, Kenya, and Senegal. But when you look at the IMF language, they're really working hard to find compromises and solutions that are acceptable. 

I would say there are, broadly speaking, three credits that we're really worried about when you think about credit worthiness and deterioration and prices. There are a few more than that, but Senegal, Bolivia, and Trinidad are clearly deteriorating credits that are mispriced in our view. And we have zero exposure across these in both frontier and the main funds. So, you know, it highlights how it's a space that you want to be thinking about, you know, absolute return. But also, there's quite a lot of pretty solid countries within this space. Some countries that are BB rated and getting towards investment grade like Paraguay, Morocco. Some countries that are solid investment grade. Some of them are quite small like Iceland, but also Uruguay. And then again, some pretty solid credit like Costa Rica and Dom Rep, which are solid and will be names which have been quite well managed. And have been doing quite well. So you can actually build a quite diversified portfolio. It's not all exposed to the pure high yielding, the highest yield countries. And that makes the universe quite interesting and quite attractive. 

Alexis, can you give us a sense of how we're positioned across the frontier strategy? And what are the top stories that investors should be monitoring?

Alexis de Mones: So you've covered some of the developments in the fundamentals that underpin some of our favourite trades,. So you're going to have some of the overlap there, and I think you did a great job at laying out the macro stories that have performed. In terms of those I would highlight, certainly Ghana is really the top story for external accounts. So the improvement in external account has been spectacular. You explained how the current account has surged into a very large surplus, which has really fuelled reserves. What they do as well, which is really interesting, is how the central bank buys gold from the local miners in local currency, puts this gold into the reserves. And then sell this gold whenever they need to support the currency, which they've been willing to do as a nominal anchor to try and stabilise inflation, which was high as a result of the devaluation a couple of years ago. So that's a good story from both the local currency and a top performing story from a local currency perspective, but remains still attractive from an external debt point of view. I'd say Ghana is more of a high single digit carry trade story as opposed to a capital gain story at this level. In local currency as well, the FX has moved quite a bit. We own it on both sides of the portfolio, but we've reduced in the local currency debt space, we've taken some profit on the FX. 

In external debt space, so best stories for notably structural reform and fiscal consolidation, one of them that doesn't receive a ton of investors' attention is Benin. So again, sub-Saharan Africa, very much in favour in the frontier debt products. So it's one of the IMF darlings, and they've managed to reach the 3% conversion rate for fiscal deficit according to the West African Monetary Union criteria. Benin is part of two IMF programmes, the Extended Credit Facility and the Extended Fund Facility, and they keep receiving rave reviews. What's interesting is that despite this progress, it still yields close to, I'd say close to 9% if you're willing to go into the long end. So that's an interesting one. 

In external debt a few are a little bit exposed to oil price volatility. So we're exposed to some of those. Angola, in our mind, is still attractive at these levels, but we fully understand that this is quite subject to and exposed to oil price volatility. I think you said that actually, it's a country that does not have an IMF programme at the minute, but has received a lot of technical support from the IMF. So were they to need financial assistance, I think they would receive it certainly from the IMF. And they've received good assistance from China over the years. So that's one to keep in mind, although it's obviously a volatile one at the minute. 

And in local currency space, so best story for reform, one we haven't actually mentioned yet, that's surprising on a webinar on frontier, is Nigeria. Following Tinubu's election two years ago, it has implemented all of the classic structural reforms and fiscal consideration reforms that the IMF traditionally pushes for. Although they're not in an IMF programme, and so save the 5% on government spending, etc. So, very much a market darling as well. Continues to be attractive from a local currency debt perspective where you have local currency. The yields are high because inflation remains high. So you have monetary policy instruments called open market operations (OMOs), they yield 25%. And you have NDFs that implies 19%, but OMOs are, you know, a market favourite in terms of instruments. And you talked about Argentina. Best story for fiscal, I'd say. Right? And that's led to this great disinflation. So we're involved. Egypt has done well, I think remains a market favourite, quite crowded. So that's one where we've gotten a little bit more cautious there. So I think this covers some of the trades that we have, and without going into the weeds too much. And we're probably ready to take questions, Stewart, if there are any.

Gustavo Medeiros: I was excited to see we also have some exposure to Iceland, which is a country that I've visited a few times. The fundamentals always look pretty good to me structurally, but then it's very hard for us to access because it's quite small for the overall funds. But, you know, for the frontier space in a diversified portfolio, it has some room.

Iceland has been probably one of the best performing currencies today, up 15%. It's been performing like their football squad in the World Cup. It's very surprising, massive outperformance. The other thing I just wanted to highlight, again, some of the real interest rates you captured there and the nominal interest rates you mentioned, Alexis. Egypt being a favourite for carry. One-year government bonds at 25% with one year ahead inflation expectations. On a conservative basis at 15% gives you, you know, the highest level of nominal interest rates in the frontier space except for Türkiye. And the highest level of real interest rates in the frontier and EM space except for Türkiye and Uganda which, again, is a tiny market with its own idiosyncrasies. But, you know, you can get Nigerian bonds also double-digit yields. You have quite a lot of great opportunities on volatility-adjusted terms. Stewart, any questions for us?

Stewart McAndie: I’ve just got a couple. You've done a great job giving us a bit of an update from a bottom up level, the countries, some of the fundamental picture. Alexis, you alluded to the fact we're slightly overweight local currency. Can you give us a feel for where we currently are, and sort of the bands that we would operate within with the strategy?

Alexis de Mones: So the currencies weighting is flexible. We reserve really flexibility to tilt quite radically, I suppose, one way or the other. So as per the prospectus, we can go either 100% either way. But in practice, you don't want to be turning around your portfolio, you know, 50% on asset allocation shifts because of the cost of trading in the space. But we are envisaging 75/25 easily either way, with a tilt towards local currency when spreads are below 500 basis points on the external debt space. So we now, in the external debt space, retain some of these attractive sort of characteristics in the current liquidity environment. But, yes, very much the bias is to increase the local currency exposure.

Stewart McAndie: And we're currently around what level?

Alexis de Mones: We're currently 55% external debt, 45% local.

Stewart McAndie: Thank you. And you mentioned trading costs. There's another question about liquidity. Can you elaborate on that? Obviously, the market size is huge, as you've already alluded to, but can you give us a bit of feel for liquidity concerns?

Alexis de Mones: So, liquidity varies depending on the markets. So the larger markets have good liquidity, and the smaller markets have small liquidity. And some of the markets trade  almost by appointment sometimes. So where you're going to have the greatest challenges in terms of liquidity is going to be in the smaller markets, where you don't have a lot of local currency debt instruments. And you're going to have to wait for an auction, or you're going to have to maybe take advantage of say, you know, a multi actually borrowing in a local currency market. And offering a new set ready to paper in local currency terms, which we don't really do a lot of that sort of so-called SSA bonds. It's standard practice in the market to do that, to access liquidity in larger size sometimes in the smaller markets. But auctions are obviously very important in a local currency debt market space. So you have to have a fully stacked trading team. And you spend a lot of time really on sourcing paper and then sourcing liquidity. And trading your position in that space more so than you do in other markets. So it's certainly something that we've been doing for a long time. So we have experience in the space. But yes, slightly more trading and a little bit less turnover than you would have in a standard product.

Stewart McAndie: I just had another question come through. How do you factor withholding taxes and transaction costs when analysing position versus benchmark, which doesn't pay the costs? Obviously, we don't have a direct-

Alexis de Mones: Yes, so, this product is managed on a total return basis. But the issue of withholding tax is obviously important. We mentioned Egypt, it has a pretty high withholding tax. So when we look at the value in an asset, we look at the net of tax if we have to pay withholding tax. So in the case of Egypt, 20% taken off of the gross yield. So it means that the real yield that, you know, Gustavo mentioned, it has to be attractive net of the tax as well. 

Now, in the more conventional main products, local currency debt products, there is actually a net of tax index that has now been rolled out by JPMorgan. So even for GBI products, we can calculate performance against the net of tax index, but it's really very small. In the case of GBI EMGD, the impact of the tax is around 20 basis points annualised yield impact. So it's not massive. But we obviously look at it and we have different clients that have different tax treatment for their positions, and we manage that accordingly as well.

Gustavo Medeiros: I just wanted to add on that. Obviously, there is quite a lot of exposure that you can get via also the direct FX market, which tends to be much more liquid. And has obviously not the same treatment, tax treatment on the bonds. So that's going to be what we're basically looking at, the total return and how much we actually have offered in excess of the carry that you have on NDF. If it's not enough and if the bonds are not tremendous value as well, then that might be the safest place where I have much more liquidity anyways. 

The liquidity on the currency markets and the transparency of the markets in places like Nigeria, Egypt, Zambia have improved quite significantly since the IMF reforms and these guys liberalising their currencies, and has been quite good. So that's very, very interesting. I think there's a product that has a lot of good characteristics. It has potential high total returns. We can pair that with relatively low volatility, thanks to the fact that we can go alternate between the hard currency and the local currency. And thanks to the fact that some of the currencies have been operated on a quasi-pegged environment. And, you know, it obviously would benefit massively from a weaker dollar. But it's much less exposed to the direct impact of global macro dynamics than it is. Similar to our frontier equity strategy, it's a strategy that is overlooked and has very appealing diversification characteristics for most portfolios.

Stewart McAndie: Absolutely, thank you Gus. Eloquently put. Thank you both for your time today, and to everybody else that's attended the webinar and everyone's questions. That was brilliant, I appreciate it. But if anyone has any other questions, please follow up with your local Ashmore representative or send through to me. We'll be sending out a replay and an email following this webinar, which you can share with your colleagues, or please reach out to your Ashmore contact in due course. That concludes today's webinar, thank you.