Idiosyncratic risk—risk that is specific to a particular asset, rather than the market to which it belongs—is often seen as something to be avoided, but can also be embraced and managed successfully, we believe. The key is to have confidence––as OFI Global does––in the quality of one’s research and one’s skill in analyzing market data and trends, and then apply these to managing a set of well understood, calculated risks with the goal of surpassing benchmark returns.
In global debt investing, idiosyncratic––or unsystematic––risk can take the form of overconcentration in or overexposure to specific geographic markets, sectors, market segments, industries, or individual securities.
“As discretionary macro managers, we perform in-depth analysis of each country, including all the economic variables as well as monetary and fiscal policy,” explains Hemant Baijal, Co-Head of OFI Global’s Global Debt team. “We also combine it with each country’s political cycle, which feeds into a worldwide view, allowing us to determine how much overall portfolio risk we want to take. We then allocate that tactically into a certain degree of rate risk, credit risk, and foreign exchange risk in an effort to create an optimal portfolio in that environment.”
During the past several years, certain markets, particularly in the emerging economies, have faced outsized idiosyncratic risks. But in some cases, these risks may be accompanied by rewards.
Volatility in Brazil, India, and Turkey, for example, currently offers the potential for attractive investment opportunities for investors who can navigate the accompanying idiosyncratic risks that are common to these markets.
Brazil: Attractive despite political turmoil
Brazil is a volatile but opportunity-rich market that OFI Global believes can reward patient and astute investors. In the short term, a political crisis around allegations of corruption has added to investment risks. Brazil also continues to face other challenges, from a growing debt burden to an inadequate education system and high production costs.
From a medium-term view, however, Brazil’s resilient economy and economic reforms are positive factors. The country has numerous strengths, including vast natural resources and a government that is refocusing on structural fiscal reforms. Last December, Brazil’s National Congress imposed a 20-year ceiling on public spending. Also under consideration: a social security reform bill that would raise the minimum retirement age to 65, resulting in significant public savings. A recent sharp increase in infrastructure spending could also lay the groundwork for a more efficient and productive economy.
Interest rates have fallen dramatically thus far in 2017, from just shy of 14 percent in January to just above 10 percent halfway through the year. The annual inflation rate plummeted to a ten-year low of 3 percent in June from roughly 9 percent a year ago. This is substantially improving the purchasing power of Brazilian households. Even the clouds created by the country’s political crisis have a silver lining in improved long-term institutional transparency.
Clearly, risks exist for Brazilian investors. But OFI Global has confidence in the government’s shift toward greater fiscal responsibility and monetary easing, expressed through our decision last year to overweight positions at various points along the yield curve.
India: Opportunities despite concerns
India has the distinction of being both a BRIC nation (along with Brazil, Russia, and China) and a member of the Fragile Five: countries with unsustainable twin deficits in their current account (trade balance) and government budget.
The past few years have marked a dramatic turnaround, however. With the government focusing on gradual, long-term fiscal consolidation, inflation plummeted from more than 12 percent in November 2013 to just 2.2 percent in May 2017, enabling the Reserve Bank of India to cut interest rates by 175 basis points to 6.25 percent since early 2015. Meanwhile, the economy has posted 6 to 9 percent annual GDP growth over the past three years.
Granted, India still has a high level of government debt, corporations in certain industries remain highly leveraged, and state banks have a high volume of non-performing loans.
Nonetheless, in our view India remains attractive. Positives include key industrial reforms and a supportive fiscal policy that aims to stimulate growth in tandem with structural reforms. Strong trade ties with the U.S. are helping to buffer India from the global trade volatility that challenges other emerging markets. Remonitization is helping to reduce corruption while expanding the country’s tax base and encouraging efficient electronic transactions.
OFI Global, consequently, has a favorable view of India. “We like both government and corporate local-currency debt while looking for tactical US dollar-rupee hedging opportunities,” Baijal says.
Turkey: A turnaround worth noting
Turkey might be the last place many investors would look for investment opportunities, but OFI Global believes it currently offers attractive returns. After a failed government coup in the summer of 2016, Turkey’s economy slowed significantly. But extensive stimulus measures––among them, temporary tax cuts and large loan guarantee programs that stimulated domestic demand––led to a cyclical recovery.
The Central Bank of the Republic of Turkey tightened liquidity conditions, producing a short-term interest rate increase of about 4 percentage points that helped stabilize the lira. The economy still struggles under a large external debt burden, ongoing current-account deficits, rapid credit growth, high inflation, and political uncertainty. But stronger-than-expected first-quarter GDP growth of 5 percent is an encouraging sign, as is the recovery of sovereign-bond credit default swaps.
We believe Turkey typically remains underrepresented in investors’ emerging-market fixed-income portfolios, and can offer investors the opportunity to seek to capitalize on trends toward tighter credit spreads to capture an additional 100-200 basis points. We find the credit fundamentals of Turkish corporate and banking bonds to be solid, thanks to regulatory vigilance, leading to healthy balance sheets. With all this in mind, OFI Global has been gradually and selectively adding to our Turkish fixed-income exposure.
Active management reduces risks
Fixed income markets displaying idiosyncratic risks contain opportunities as well as pitfalls for investors. We feel the three examples above, along with others including China, France, and the UK, all provide opportunities to actively manage idiosyncratic risk through rigorous research.
“In a benign environment, typically all boats are lifted,” says Wim Vandenhoeck, Co-Portfolio Manager of OFI Global’s Emerging Markets Local Bond Strategy. “But as the market becomes more volatile, active management truly has the potential to pay off.”
Learn how we challenge expectations with our Emerging Markets Local Bond Strategy.
OFI Global is not affiliated with Institutional Investor. Products offered through OppenheimerFunds.
Fixed income investing entails credit and interest rate risks. Interest rate risk is the risk that rising interest rates or an expectation of rising interest rates in the near future will cause a portfolio's investments to decline. Risks associated with rising interest rates are heightened given that rates in the U.S. are at or near historic lows. When interest rates rise, bond prices generally fall, and the value of the portfolio can fall. Below-investment-grade (“high yield” or "junk") bonds are more at risk of default and are subject to liquidity risk. Foreign investments may be volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes, regulatory and geopolitical risks. Emerging and developing market investments may be especially volatile. Investing a significant portion of assets in a single issuer may increase volatility and exposure to risks associated with a single issuer.
The mention of specific countries, currencies, securities or sectors does not constitute a recommendation on behalf OFI Global.
OppenheimerFunds is not undertaking to provide impartial investment advice or to provide advice in a fiduciary capacity.
OFI Global Asset Management (“OFI Global”) consists of OppenheimerFunds, Inc., and certain of its advisory subsidiaries, including OFI Global Asset Management, Inc.; OFI Global Institutional, Inc.; OFI SteelPath Inc.; VTL Associates, LLC; and OFI Global Trust Co and SNW Asset Management, LLC. The firm offers a full range of investment solutions across equity, fixed income, and alternative asset classes. The views herein represent the opinions of OFI Global and are subject to change based on subsequent developments. They are not intended as investment advice or to predict or depict the performance of any investment. The material contained herein is not intended to provide, and should not be relied on for, investment, accounting, legal, or tax advice. Further, this material does not constitute a recommendation to buy, sell, or hold any security. No offer or solicitation for the sale of any security or financial instrument is made hereby.