MFS® Emerging Markets Debt Strategy - Quarterly Portfolio Update

Hello, and thank you for taking a few minutes to hear about Emerging Markets Debt. I am Katrina Uzun, an institutional portfolio manager overseeing Emerging Markets Debt strategies at MFS^®, and I’d like to share our perspectives on the global macro environment and our high-level portfolio positioning.

 This past quarter was marked by contrasting halves. Early in the quarter, markets were unsettled by stronger growth and upside surprises to US inflation data. This sparked concerns that the Fed efforts to control inflation might not be sufficient. However, as the quarter progressed, US inflation data moderated and labor markets began to show signs of normalization. This shift should allow the Fed to deliver nonrecessionary rate cuts this year, perhaps as early as September. Our base case now assumes a soft landing in the US, which is supportive for risk markets.

 With cooling inflation in the US, we are seeing a similar trend in emerging markets. By the end of May, 80% of the countries in the local currency index had inflation rates at or below their targets, allowing emerging market central banks to cut rates. And they have been doing so for some time now but had to slow down since the Fed has not yet begun its own rate cuts. Once the Fed starts cutting, emerging market central banks will have room to continue their rate cuts because current real rates in many of these economies remain high and restrictive. As inflation continues to fall, we expect the rate-cutting cycle to continue and potentially even accelerate once the Fed begins its cuts.

 And we have to talk about elections. 2024 is a big year for elections in emerging markets countries. There are 16 elections this year representing a quarter of the index in market value, and a third of emerging markets GDP. And there have been a few notable surprises in the elections held so far this year, one of them being in Mexico. We significantly reduced our overweight position in Mexico prior to the election. While we expected Claudia Scheinbaum to win the presidency, we were concerned about the tail risk of the ruling party securing a constitutional majority. As a result, we reduced our quasi-sovereign exposure, particularly in names that were already at a two-year valuation high. We were also concerned that the constitutional majority could negatively impact certain sectors, such as the electricity sector, so we reduced our exposure there.

 South Africa also had an election surprise, but a positive one. Remarkably, the African National Congress, which had maintained a majority since its founding in the early nineties, lost its majority and had to form a coalition with a market friendly party to govern the country. This new government is expected to implement improved policies, and as a result South African assets have outperformed since the election.

 And of course, we cannot overlook the upcoming US election later this fall, which we believe will be a tight race. If the Democrats win, we likely won’t see significant policy changes from the current Biden administration. However, if Donald Trump wins, it will be important to see if the Republicans can hold the Senate and retain the House. In that scenario, we may see a stronger dollar, higher rates, and perhaps even a weaker currency in China. Even without a Republican Congress, Trump could take actions on trade and immigration, which might negatively impact some emerging market countries. However, during his first presidency, despite his rhetoric, emerging market economies did fairly well, so we do not expect a substantially negative impact on them overall this time either.

 The global backdrop is supportive for risk. With generally positive growth, good external balances, high real rates and the disinflation in emerging markets, the overall background for EM is quite favorable. However, relatively tight valuations and potential volatility around the upcoming fall elections keep us cautiously positioned. Our strategy has focused on an up-in-quality trade, adding stable, improving credits with strong balance sheets. For example, we favor countries like the Dominican Republic, Paraguay, Costa Rica, Serbia, Morocco – all BB-rated economies with strong and improving balance sheets, sound policies and low macroeconomic imbalances. Similarly, on the corporate side, we seek companies likely to be more resilient in a risk-off scenario.

We have maintained local duration overweights in countries where policy rates remain above neutral and economic growth is below potential. However, we are underweight currency exposure as we need the Fed to start cutting rates for the dollar cycle to turn. Once the dollar weakens, emerging market currencies can rally, providing a better entry point into the local currency market.

Thank you again for your time and continued trust in us to create value for you, our investors, responsibly.

 

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The views expressed are those of the speaker and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice from the Advisor. No forecasts can be guaranteed. Past performance is no guarantee of future results.

 

Important Risk Considerations:

The strategy may not achieve its objective and/or you could lose money on your investment.

Bond: Investments in debt instruments may decline in value as the result of, or perception of, declines in the credit quality of the issuer, borrower, counterparty, or other entity responsible for payment, underlying collateral, or changes in economic, political, issuer-specific, or other conditions. Certain types of debt instruments can be more sensitive to these factors and therefore more volatile. In addition, debt instruments entail interest rate risk (as interest rates rise, prices usually fall). Therefore, the portfolio's value may decline during rising rates. Portfolios that consist of debt instruments with longer durations are generally more sensitive to a rise in interest rates than those with shorter durations. At times, and particularly during periods of market turmoil, all or a large portion of segments of the market may not have an active trading market. As a result, it may be difficult to value these investments and it may not be possible to sell a particular investment or type of investment at any particular time or at an acceptable price. The price of an instrument trading at a negative interest rate responds to interest rate changes like other debt instruments; however, an instrument purchased at a negative interest rate is expected to produce a negative return if held to maturity.

Emerging Markets: Emerging markets can have less market structure, depth, and regulatory, custodial or operational oversight and greater political, social, geopolitical and economic instability than developed markets.

International: Investments in foreign markets can involve greater risk and volatility than U.S. investments because of adverse market, currency, economic, industry, political, regulatory, geopolitical, or other conditions.

Derivatives: Investments in derivatives can be used to take both long and short positions, be highly volatile, involve leverage (which can magnify losses), and involve risks in addition to the risks of the underlying indicator(s) on which the derivative is based, such as counterparty and liquidity risk.

High Yield: Investments in below investment grade quality debt instruments can be more volatile and have greater risk of default, or already be in default, than higher-quality debt instruments.

Please see the applicable prospectus for further information on these and other risk considerations.

The portfolio is actively managed, and current holdings may be different.

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