European equities: Finding emerging market exposure

Christoph Riniker, Head of Strategy Research, Julius Baer - Martes, 09 de Septiembre

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• We maintain our constructive view on emerging markets and see tailwinds especially from a valuation perspective. • For risk-conscious investors European stocks with high emerging market exposure might be an attractive alternative to direct investments in Chinese or Indian equities.

Some weeks ago we have turned more constructive again on global emerging markets. Especially in Asia (still our most preferred emerging region with overweight ratings in China, India and the frontier market Vietnam) but also in Latin America, the relative performance compared to the MSCI All Country World has substantially picked up. MSCI EMEA (covering emerging countries in Europe, the Middle East and Africa) is still suffering from geopolitical uncertainties. However, there could be light at the end of the tunnel. From a valuation perspective emerging markets see further tailwinds.

Investing into the region is not the only way to take advantage of a positive development. It can also be rewarding to invest in equities from developed markets which have a substantial sales expo-sure to emerging markets. From a regional perspective, Spain and Germany are the two markets with the highest exposure to emerging markets. From a sector perspective the top three include materials, financials and industrials with information technology and telecom following closely. Gaining emerging market exposure via developed markets stocks with substantial sales exposure to emerging markets provides similar return patterns in terms of trend but not in the extent of the performance given the lower risk exposure. While setbacks are partly protected, up-swings are not followed completely. As we turn more constructive on emerging markets again, this approach therefore might make sense for risk-conscious investors or persons who are not allowed to adopt emerging market exposure.

Markus Allenspach, Head of Fixed Income Research, Julius Baer

 

European bonds: New credit default swaps protocol

 

• The new credit default swaps protocol will come into effect this week. It may solve some deficiencies but is no panacea.

• A cautious stance on subordinated bank debt is advisable. Investors should limit their positions to top-rated banks only.

Friday this week, the ‘ISDA 2014 Credit Derivatives Definitions Protocol’ (new protocol) will come into effect for a defined range of transactions. The previous ISDA protocol was established long before the Lehman crisis and has some deficiencies. Its list of credit events did not include government-ordered bail-in of subordinated bank debt. This means that if the regulator asked for a write-down of subordinated debt outside a default, this would not trigger a CDS payment. Another problem is the restructuring of a struggling bank into a bad bank and a new bank.

The new protocol will come into effect for all transaction done after 12 September 2014, 5 p.m. New York time. Given the better protection, new CDS should be more costly than the old ones. Yet for the time being, the new protocol will only apply for US units, while most European banks and sovereigns as well as large Asian names are excluded. Since the CDS indices for subordinated debt mostly include both US and European banks, it is hard to say how the indices will react.

Given the decline in the yield of contingent convertible (CoCo) notes of European banks in recent months and regulatory uncertainties, investors should become reluctant to enter the risk of CoCo investments in general and limit their positions in bank debt to top-rated banks only.

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