Buying Credit Default Swaps can be a valid hedge for fixed-income investors’ exposure to emerging markets currencies, according to Dresdner Kleinwort Wasserstein. “We believe there is justification for considering FX versus CDS strategies during periods of heightened nervousness where investors may be concerned about an increased risk of some catastrophic market weakness,” analysts Jon Harrison and Sabrina Jacobs wrote.
The hedge is only effective in markets where CDS spreads are relatively volatile compared with the bid-offer spread and where the CDS and currency markets are both influenced by similar factors, the bank noted. Brazil, Mexico and Turkey present suitable candidates but Russia and Central Europe do not.
The hedge is likely to become less effective in future and can lose money in stable or improving markets, the analysts warned.
Dresdner’s emerging markets economist Arnab Das recommends “cash-plus” positions, warning that assets in developing economies may continue to suffer. Short-dated sovereign debt in countries with low credit and market risk but higher yields on bonds than cash, or markets with few carry trades and small financing requirements like Russia are his picks.
Credit Suisse says their equity model suggests investors go overweight on Taiwan and underweight Korea. Recent weeks have made South Africa and China more attractive and diminished the case for Brazilian and Russian stocks, according the model. However, Credit Suisse analysts note that the model tends to underestimate the value of markets undergoing structural re-ratings. The model also points to an overweight position on Turkey, backed by the bank’s analysts, and underweight on India and Mexico.
The Russian economy needs more investment, and specifically more foreign direct investment, to boost economic growth, according to Renaissance Capital. Annual investment will have to climb from 10.9% last year to 12.7% to reach the rate needed to support a doubling of the size of the economy in a decade, researchers Vladimir Pantyushin and Olesya Cherdantseva estimated. Instead, with factories and equipment aging rapidly, the investment dynamic is slowing.
Deutsche Bank reported that emerging markets are at a “crossroads.” “We see limited upside and potentially large downside,” ahead of next weeks US inflation data, analysts Marcel Cassard, Marc Balston and Piero Ghezzi wrote. The backed long positions in Peruvian, Brazilian and Venezuelan credit markets against short on Turkey, Ukraine and Colombia. On equities they suggested buying underperformers like Malaysia, Taiwan and Israel. Russia and China will also be attractive if concerns about a global economic slump dissipate, the report said. Deutsche warned investors to avoid stocks in Turkey, India, South Africa and Mexico.
Argentine assets are among the most attractive in Latin America, according to BCP Securities’ Walter Molano. Soft commodity exports, especially grains, will support strong growth while strong revenues have led to a wealthy and stable government, Molano notes. Rumours of a planned buy-back of GDP warrants are also positive, he states.