John Carlson of Silver-rated Fidelity New Markets Income explains why being focused on U.S. dollar-denominated bonds has served the fund well.
Karin Anderson: Hi, I'm Karin Anderson. I'm an associate director of fixed income in Morningstar's manager research group. I'm here today with John Carlson, who is the manager of Fidelity New Markets Income.
Hi, John. How are you today?
John Carlson: I'm well, Karin. How are you?
Anderson: Good. Thank you. Thanks for talking with us.
Carlson: Thanks. It's my pleasure to be here.
Anderson: Great. Maybe we could start out by hearing why as an emerging-markets bond investor you've been conservatively positioned over the past couple of years?
Carlson: Yeah. I think coming out of the Great Financial Crisis in '08 there was an opportunity in '09 and 2010 to really take advantage of spreads that had blown out. But since that time if you look at how the world has changed with negative interest rates, falling commodity prices, everything that was a tailwind that was pushing emerging markets probably from the early '90s straight through till '08 has suddenly started to reverse. And when you put that in perspective, I felt there was a time at least through the end of last year to be more conservative.
Anderson: And what does that mean exactly? Historically, you've been very focused on the hard currency market. Those are the dollar-denominated bonds. What does that mean exactly?
Carlson: So, for me, I was staying a little bit closer to home. I track against the benchmark. So, I'm a benchmark person who is aware of the benchmark, but I'm also wary of the benchmark. It can lead you to places you may not want to go. Just because it's large in the benchmark in terms debt, may not be a place you want to go. So, I was staying closer to home, dollar bonds, not so much in the corporate sector, more sovereign and really trying to lather the portfolio across and avoiding those credits that I thought were not priced for the risk involved. So, in some cases, it might be Venezuela, where I've been overweight, but I think the bonds have been pricing in more than the risk that is there and I think the recovery value is higher than where they are priced now. So, I remain overweight.
Anderson: OK, great. So, maybe you can talk to us a little bit about just the run that hard currency has had compared to local currency bonds. Given that it's been an area of relative strength within emerging markets, what are some of the red flags at this point? Is it from the credit side?
Carlson: I think, again, there's probably 75 to 80 credits in my portfolio on the sovereign side, so each one is unique. But I think in aggregate the local currency was the shock absorber during this crisis period and so a lot of these currencies blew way out. The ruble went from the low 30s to 80-something. Brazil, the same type of story. So, these currencies have been down 30%, 40%, even 50% in some cases. So, with that in mind, I've actually started to look at adding some local currency exposure here in the last couple of months. So, I think it's been overdone. I think we're reaching more of a balance. I know this is a bit of a not a consensus view right now, but I think growth in China is slowing, perhaps growth in the U.S. is picking up. There will be more of a balance going forward. So, I'm beginning to look at where I see currencies that have been oversold either on the basis of fundamentals or political noise.
Anderson: Got it. And one last question for you: Brazil has been an overweight for a couple of years now. You made bigger moves into that space in 2015. Tell us why.
Carlson: Well, I actually think revealing the corruption is a good thing, and when I look at the strengths that Brazil has and it's been almost primarily in dollar, sovereign and most recently, Petrobras bonds, I find real value. So, Mexico gets a lot of the credit for having managed their external debt well, but so should Brazil. It's only about 5.5% in the index and when I joined Fidelity in 1995, it was 33%. Now, you can say, yes, the index was smaller and there were 12 countries, but Brazil has done an amazing job in reducing their external liabilities on the sovereign side. So, again, I think when it happens in politics, people tend to overreact and based on both travel to the region, discussions, and looking at some of our fundamental models, I felt it was way too cheap for the credit it was.
Anderson: John, thanks so much for being here today.
Carlson: No, thank you, Karin and all of Morningstar. It's my pleasure.
