Polina Kurdyavko - Navigating Emerging Markets

00:00:07 [Polina Kurdyavko]
And the reason why I went into this profession is because my family lost all their personal money three times in my life history. And so I felt that it was important to understand what drives crises in emerging markets and how can I be crisis aware.
00:00:24 [Vincent Weber]
Hi, everyone. Welcome back to Resonanz Spotlight. I'm Vincent Weber, your host, and I'm really glad you're tuning in. Today, we are breaking down emerging markets. what's driving them, the risk and opportunities ahead, and how investors can navigate them successfully. Joining me is someone with deep expertise in this space, Polina Kordiavko. Polina heads the Emerging Marketing Desk at RBC Blue Bay and manages some of their most influential EM-focused funds. Polina, thank you for being here. And to start, can you just share a bit about your role and how your team approaches investing in emerging markets?
00:01:03 [Polina Kurdyavko]
Vincent, it's a pleasure to be here. Thank you for inviting us and thank you for raising this very important topic, the emerging market fixed income as an asset class and what are the opportunities and the risks in this asset class in these uncertain times. I guess taking a step back and thinking about how we approach emerging markets. My team, which is a relatively large team of seasoned professionals with over 20 years of average experience, mostly is the team of individuals that have emerging market personal background, but professional developed market credit training. And for us, when we look at emerging markets, we feel that as investor, looking at fixed income as an asymmetric asset class in terms of risk reward.
We're often operating on, to some degree, what one would call worst case mentality, understanding what is the downside risk in the credit event, because the upside often is relatively limited to the coupon, unless, of course, you're looking at investments at distressed cash prices. So I would say that in terms of our philosophy, it resonates with our background. I started investing in emerging markets in 98, just after a Russian financial crisis. And the reason why I went into this profession is because my family lost all their personal money three times in my life history. And so I felt that it was important to understand what drives crises in emerging markets and how can I be crisis aware next time when these crises occur.
And so for me, when you have that type of crisis mentality, it actually fits quite well with the fixed income as an asset class, because you are focused on the downside risks. And for us, generating returns in the emerging market fixed income, it's all about capital preservation. It's about focusing on deep fundamental approach, which we call based on mosaic theory, where actually we spend collectively about 70% of our time on the ground in emerging markets. And those emerging markets are actually 80 plus countries across three different time zones. And we collectively look at the best and the worst risk reward within a particular country and then express the views across our investment strategies, both in relative and absolute return form.
00:03:54 [Vincent Weber]
Right. So you start your career as a particularly scary time for emerging markets. I recall the Russian financial crisis in 1998. So really a time where most people would just run away from not only risk, but emerging markets. So, I mean, this might have taught you a lot. So are there some key lessons you took from that experience that's still relevant to your day-to-day investing?
00:04:22 [Polina Kurdyavko]
I think that. Firstly, I would highlight that periods of distress tend to be closely followed by periods of abnormally high returns. And your ability to capture this turn and protect your downside when assets go into distress and then capture the upsides on the recovery after the distress really determines whether you are able to consistently generate a return, positive return in any asset class. And obviously emerging markets being a more volatile asset class with a lot of different economic cycles and hence crises occurring in different countries for different reasons is a perfect case study for that. So that's point number one. Point number two is when I look at the emerging market fixed income as an asset class.
And at RBC Blue Bay, we manage a broad range of strategies across the liquid, illiquid, relative return, absolute returns. Often when I speak to investors and they say, okay, we will look at the emerging markets, but we're not really positive on beta at the moment. So we'll look at all of the strategies maybe when we're a bit more positive. And I think it's important to differentiate. where you can generate performance. Because when you're managing absolute return strategies, actually the focus is on generating performance through volatility, not through the directional bets.
And that's why if you can successfully execute on the strategies in the absolute return space, you can deliver consistent double-digit net returns over the last decade, where when you look at the asset class on the index level, the returns were close to zero on the annualized basis. So that's the second takeaway. There is opportunities in volatility, not just in directional moves in emerging markets. And to me, the third takeaway would be when you look at emerging market fixed income and you try to make your investment recommendations based on the number of disparate sources of information. To me, the fundamental knowledge always outweighs any valuation matrix you can put on it. At the end of the day, you can get the valuations wrong, but if you get fundamentals wrong, that really defines your performance, long-term performance.
Therefore, my advice would be, do not be afraid to ask questions. Focus on the fundamentals. And if you don't understand, if something doesn't make sense to you, don't invest. It means something is not quite right. Most things can be explained to my 10-year-old son, and he would understand it. Then you feel that you actually understood what are the real risks in a particular story. If you can't, maybe look for other opportunities.
00:07:21 [Vincent Weber]
Thank you. So let's move forward. If we look at last year, 2024, this was a game changer for emerging markets. There were so many elections, policy shifts, and rising geopolitical challenges. Looking at the current year, what do you think the EM landscape is now and what opportunity do you see on the horizon?
00:07:43 [Polina Kurdyavko]
I think 2025 will be a very interesting year because it's a year where, on one hand, when we think about fundamentals, and again, I always start with fundamentals, we expect zero default rates for the sovereigns. and we expect default rates for emerging market high-yield corporates to be meaningfully below historical average and also below default rates for U.S. high-yield corporates and European high-yield credit. Generally, when you have very constructive default outlook, your spreads should follow your default outlook. And so from a fundamental standpoint, you should expect broadly spreads to compress at the asset class. However, We also are in unprecedented times where with the U.S. new leadership, we're really changing the framework in the way the world operates on so many levels, from trades to geopolitics to migration.
Every single level of economy is being potentially affected by this. And this creates volatility. So for us, the opportunity actually. for 2025 lies in being able to trade that volatility on a short-term basis. This is not a year when we think you can take a directional view. This is the year where you can trade short-term vol and actually your short-term vol could be multiple of your long-term vol. And in order to be able to trade this volatility, it's all about risk sizing and positioning because you want to be able to hold on to your positions to preserve your positive performance.
00:09:28 [Vincent Weber]
So talking about this US shifting policy, so how do you see those impacting EM issuers?
00:09:37 [Polina Kurdyavko]
Well, I would start by saying, for once, we can dilute the EM tag. Because this time around, it's not about DM versus EM. It's about US versus the rest of the world. And it's interesting that we're discussing issues like Greenland debate or the tensions between Canada and U.S. with, if you will, as much involvement as investors had in the past between discussing Mexico-U.S. negotiations. So I think that's an important distinction to make. When I think about how the issues would be affected, again, splitting it in simple ways between the impact on fundamentals and then the impact on the technicals. From a fundamental standpoint, when we think about tariffs, we view tariffs as a tool. We don't view tariffs as the goal.
The goal can be led by, to quote the new president, making America great again when it comes to its, if you will, world leverage, world supremacy. We can talk about the goal being migration, addressing the immigration challenges, which has caused a lot of social unrest in the US. But tariffs are the tool to achieve this goal because tariffs can be effective short term, but ultimately in the medium term, there's a lot of statistics that proves tariffs leads to global growth being weaker. Across every single country, there is no winner in tariff control. We actually don't expect the tariff war to have a meaningful negative impact on the economics.
As we've seen on the example of Colombia or other countries that have started negotiation with, if you will, big headlines on tariffs, but actually ended up within 48 hours agreeing on a much more benign outcome. So that's the first point that I would make. And that matters for emerging markets. I think the second point that I would make is if I think about geopolitics, I do believe that Trump can have, for the lack of a better word, a global pacifier effect. Because if we look at the evolution of situation between Israel and Iran and US trying to broke a peace deal within the region, there is a chance of reaching a peace deal that has not been reached for years.
Equally, Russia-Ukraine peace negotiations, which we are seeing a lot of headlines about, could bring a resolution to now a two-year-long war. When it comes to geopolitics, we feel that actually the impact, the potential risk would be on the upside as well as the downside. When I think about the downside risks, I think the downside risks are mostly in two areas. One is the area of sustainability, because just from what we see, this is not something on top of the U.S. president's agenda today. And second, the weakest countries in emerging markets that do rely on support from the U.S. and other multilateral organizations. We've heard some headlines about potentially that support being unwound. And the key question mark will be when the support gets unwound, who steps in to provide the support?
Now, we have interesting geopolitical reasons why this support could be provided for example middle east as a if you will relatively rich overall neighborhood could could be interested in providing control support to countries with a weaker credit rating such as egypt It will be very interesting to see how China plays this card as well, because they have been quite actively involved in some of the weaker emerging market countries for years. But I think that will be very interesting reshaping. Now, those countries that don't have the lender of last resort will be also negatively affected.
00:14:19 [Vincent Weber]
So that's pretty a bit. Let me summarize it. So your analysis of tariff, because I'm just reading the news flow this week. I got pretty scared, but I think you make interesting point that could even have a positive impact. And to let me rephrase that, where you see more probably like weaker negative impact is on the weakest countries. The weakest country be more afflicted by being in a way neglected by the US. Is that correct?
00:14:54 [Polina Kurdyavko]
Correct. And we're talking about, again, when we say the weakest, we're not just talking about, for example, the high-yield countries like your Turkey's or, if you will, Colombia's of this world. We're actually talking about very small frontier markets that have limited access to capital in the first place and therefore rely on some donor support or some multilateral involvement. Now, I should also caveat, Vincent, that these countries have just gone through double-digit default cycle. So, we've seen the biggest default cycle in the emerging market sovereign history over the last five years. Therefore, interestingly, the deterioration in support might not necessarily result in higher defaults, which is what we care about as credit investors, but it is likely to result in a much weaker growth profile, at the very least.
00:15:56 [Vincent Weber]
Right. Thank you. You briefly mentioned China, so obviously the elephant in the room when it gets to the emerging market. So do you think the government's effort to boost growth will be successful?
00:16:13 [Polina Kurdyavko]
Over the years, I've been very impressed by Chinese policymakers. And we spend a lot of time on the ground in China. We have very good access to the policymakers as well. And I feel that contrary to common belief, it's actually relatively straight, easy, I would say, to get an understanding what is the policy, because the policymakers tell you what the party line is and then deliver on it. So when it comes to the objective of growth, To me, we are operating in slightly different time horizons. I would generalize, but I'd say for the Western investor, if they deliver on growth, they have to deliver on growth in the next quarter or in the next month, because that's what will drive my monthly P&L.
When we think about China, I feel that their time horizon is substantially longer than ours. And therefore, My interpretation on what is happening today when it comes to growth targets in China is really very much linked to the global uncertainty. If I were president of China, seeing the uncertainty that we have today on tariffs, I wouldn't be rushing to unleash the domestic stimulus to support growth because this is the measure that I can always use. And I know that my country can have the largest resources to unleash fiscal stimulus compared to majority of other countries in the world, given the structure of my economy. But what I also know is that I don't want to waste stimulus if I know that there's much tougher or different conditions, if you will, economic conditions coming my way.
To me, it's all about patience when it comes to China. I think once we get a better visibility on the tariffs, on the new engagement, on the new allies, which could be forms, because don't forget that, if you think about US policies, they've been very upfront with many countries in terms of willingness to change their trading relationship. And naturally, There's likely to be conversations between China and these countries to see if some alliances could be formed as a result of that. So I think we are at the historical moment where so many relationships are being rewritten that Chinese stimulus is something that will come and can be very effective once we have more visibility on the new state of play.
00:19:07 [Vincent Weber]
Okay, thank you. So another big topic is currencies. EM currencies have been under pressure for years as capitals flow to the US. So what's your take now on where EM currencies are headed compared to the US dollar?
00:19:25 [Polina Kurdyavko]
Currencies are always an interesting topic to discuss because unlike credit spreads in dollars that are always anchored by default outlook, currencies don't have an anchor. We have many anchors and many valuation points, which makes currencies the lowest information ratio asset class out there. With that said, from a valuation perspective, when we look at currencies, I was looking at actually a very simple chart, which is just a real effective EM exchange rate aggregated over the last 25 years. And we're now trading below the late 90s crisis. in terms of real effective exchange rates. So we have priced in a lot of bad news. But as we know, valuation is never an anchor to a story on its own.
But it can help protect the downside, which is why if I look at the best performing asset class year to date within fixed income, it's emerging market local currency. Because despite all the tariff headlines, we're actually seeing Brazilian REI rallying 7%. partially reflecting how oversold the currency has been over the last few years. So that's the first point I would make on the valuations. The second point that I would make is that generally, currencies follow the trend on growth and current account dynamics. Now, there is a lot of growth uncertainty in the current world. And we could see that actually, In this uncertain world, if inflation anchor is in place, we might actually see a relatively benign environment for EM currencies.
In fact, if you recall, Vincent, when Trump came to power last time around, the first half, there was a bit of a freeze. We have seen a drop in economic activity. I do think that we could see a repeat of that this time around in the uncertainty. You pause and you reflect and ultimately you then take action. Therefore, if global trade volumes drop, we could see more benign inflation numbers, which could actually help risk assets. However, ultimately, as these tariffs kick in, as the rhetoric becomes more protectionist, naturally, you should see inflation going higher, not lower. And the biggest risk for EMFX will be rate hikes. And so to me, for all risk assets, there's one single risk this year, U.S. rate hikes, because the world is not ready for them.
And so to me, provided we're not, and this is not what market is pricing in either, provided we don't see rate hikes, I actually could see EM local risk doing very well and potentially outperforming hard currency this year. But of course, the tail event is quite important to keep in mind.
00:22:27 [Vincent Weber]
Okay, thank you. Very interesting. We talked a lot about what's happening now, but let's take a step back and look at the big picture. Where do you see emerging market heading over the next five to 10 years?
00:22:49 [Polina Kurdyavko]
I see an interesting path for emerging markets. Let me take back the last take. take a look back at the last 25 years and say that when I started my career, I thought it's a brilliant asset class. there's so many countries that are growing, they're lower levered. Surely, 25 years forward, I shall be seeing an emerged asset class with a lot of countries migrating, delivering and really becoming developed market economies. If I look at what has happened, my asset class combined grew.
to 30 trillion dollars so actually when i started it was probably 10 times smaller so the volume has increased but if i think about the countries that are there they're still the same names and if i think about the average ratings that we have i mean on average you've seen a small improvement but we're we're not we haven't re-rated as a universe and so If I think about what has really changed over these 25 years in these countries, I'd say the biggest change was on the monetary side, where monetary policy became a lot more orthodox. And that's what helped currencies become the shock absorbers. And that's what made emerging markets more resilient, because today over 85% of the universe is in local currency.
And it's removed the hard currency dollar vulnerability of emerging markets, which was a very the key vulnerability when I started my career. Now, having talked about the history, and I do believe history tends to repeat itself in emerging markets, looking forward in the next five to 10 years, to me, I see an environment where we're going to have relatively low defaults on the sovereign side still, but we're going to have a lot of volatility driven by fiscal. Because In the world of relatively low growth, fiscal pressure becomes the core pressure. we've spent a lot of time talking about inflation, but a lot of it has been driven by COVID and the number of factors that were a little bit out of our control. But ultimately, for countries with democracies that are not.
Let me reword it. Even for countries that are investment graded, that have a lot of access to capital, that have democracies, ability to lose in fiscal is relatively constrained. For countries that don't have that freedom, it's even more difficult to keep fiscal intact because ultimately that means if you cut fiscal spending, you almost increase the probability of social unrest. If you don't cut fiscal spending, the local currency and the market will punish you quick enough that you realize these policies are unsustainable, which puts leaders in a very vulnerable position. So I would expect in the next five to 10 years to continue to see more changeovers, like we've seen more recently, some protest votes. And led to that fiscal anchor, which is so difficult to maintain in the low growth environment.
That will cause the volatility. With that said, what makes me more constructive? What makes me more constructive is the implementation of some structural reforms that we haven't seen for a long time. I have to be very blunt and say. Structural reforms don't happen because people are living well and they want to live even better. Structural reforms sometimes need to happen when everyone is on their knees and there is no other way out. And a few countries have experienced that over the last few years. Nigeria would be a good example, the country which avoided default, but definitely had a lot of structural issues, which they are trying to fix right now and so far relatively successfully.
To me, the opportunity cost or the opportunity for those countries like Nigeria would be if they follow through on that, they could actually migrate into the South Africans of this world because the potential is there. But obviously, delivery key will be in the delivery. That's just to balance it out with a caution and a positive note.
00:27:24 [Vincent Weber]
Okay. Great. Thank you, Paulina. One final question. What advice would you give to young people who are looking to break into the world of EM or investment management more broadly?
00:27:39 [Polina Kurdyavko]
Firstly, I would say that if you decide to work in the finance industry, you have to take this decision because you really won't like investing. not because it's an industry which is known to be, if you will, attracting the brightest and the smartest. To be fair, some of this has already rubbed off over the last few years. But nevertheless, I think that the industry has changed so much with the amount of deregulation, the amount of compliance that one has to adhere to, that you really want to work in finance. When it comes to emerging markets, I think that I view emerging market investors a little bit as ambassadors because at the end of the day, we invest in these countries, but we also want to help them grow and help them improve.
And when countries have limited access to financing, your ability to do so is much higher because you become the lender of last resort. And that's when you set your terms. And that's why I would say, contrary to common belief, we actually have more influence on some of the emerging market issuers than a traditional debt investor would have. And I think these influences have to be used in the best interests of the longer-term prosperity of these countries.
00:29:14 [Vincent Weber]
Polina, it's been such a pleasure having you on the show today. Your insight into emerging markets are truly inspiring, and I know our listeners will walk away with a lot to think about. To everyone tuning in, visit resonancecapital.com for more information on the show. Subscribe to our blog and newsletter for fresh insight on hedge funds, liquid alternatives, and quantitative investment strategies. Thanks for listening. See you next time.