The world’s largest publicly-traded hedge fund is bracing for a selloff in emerging markets, a view that pits it against bulls at some of Wall Street’s biggest investment banks.
This year’s spectacular rally in risk assets isn’t justified by improvements in economic fundamentals and is set to reverse, according to Man Group Plc, which manages $138 billion in assets, almost half of them within Europe, the Middle East and Africa.
“We are expecting the selloff within the next two months,” Guillermo Osses, the fund’s New York-based head of emerging-market debt strategies, told Bloomberg in an interview. “People have added exposure, probably a large part of the rally has already taken place, and now find themselves very long on risky assets with very tight valuations when the liquidity conditions are turning. This is why we think you will have a significant selloff.”
London-based Man Group shares are up 23% so far this year, compared with a 6% gain on the FTSE 100. Its bearish view on emerging markets contrasts with optimism at fund managers from Morgan Stanley Investment Management to Goldman Sachs, while even some bulls say the ferocity of the rally has them getting more selective.
The Year’s Emerging-Market Rally Is Already in Danger of Slowing
Osses declined to comment on the group’s positioning or recommendations, citing company policy. The EM debt fund he manages outperformed 99% of peers last year, when it warned of default risk and eked out a 2.4% return, compared with an average 14% loss among peers, according to data and rankings compiled by Bloomberg.
Osses’s call is largely based on a decline in the US Treasury’s cash balance since late October, which he says amounts to a massive injection of liquidity that’s been overlooked by investors. The Treasury’s cash parked at the Federal Reserve dropped by some $349 billion over a period from late October to mid-January, although it has since risen somewhat.
He said the extra cash in the financial system from the US explains why there haven’t been major market responses at times even to “terrible fundamental news” in emerging markets.
“The only explanation in our view that we can come up with for the significant rally is the liquidity injection from the US Treasury,” Osses said. “The price action in the market is not consistent with fundamentals because this liquidity injection was massive. That is why the assets elevated and, we believe, ignored news about fundamentals. People rationalize these things after a rally.”
Emerging-market bonds had their best rally in more than a decade last month, with hard-currency debt returning about 13% since mid-October. Many investors have returned to the asset class on bets the Fed will halt interest-rate increases and China’s reopening will spur economic growth in commodity-producing developing nations.
Morgan Stanley Investment Management, which has $1.3 trillion in assets under management, said earlier this month that it was switching out of US equities to add exposure in developing markets. JPMorgan Asset Management and Legal & General Investment Management forecast that EM debt would hand investors as much as 10% this year.
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EM-dedicated debt funds have attracted $8 billion in the year to Feb. 1, according to Bank of America analysts, citing EPFR Global data.
The measures that the US Treasury began implementing in January have reversed the evolution of its cash balances at the Fed, Osses said. In late January, its balances at the Fed increased, producing a reduction in liquidity that operated as quantitative tightening and coincided with a reversal in Treasury yields.
“We are expecting the withdrawal of liquidity is going to produce a selloff, and the selloff is going to be made worse by the fact that investors own a lot of risk and they have larger positions that they need to liquidate,” he said.
He also said he was skeptical that China’s reopening would bring stimulus to other emerging nations, citing Chinese credit close to record lows. “While some say that commodities demand from China will support EM countries, we don’t see data consistent with such a hypothesis,” he said.
--With assistance from Christopher Anstey.
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