In this paper, Marshall Stocker, Ph.D, CFA, explores the key drivers of sovereign bond ratings, spread performance and frequency of defaults, paying particular attention to the determinant role that economic policy plays.
The triumph of free markets following the collapse of command economies from 1989 to 1991 made clear which economic system produced superior socioeconomic outcomes - at least, so far as the outcomes could be observed anecdotally.
By the 1990s, academicians began to empirically measure levels of economic freedom; the Fraser Institute's Economic Freedom of the World Index, first published in 1996,¹ and the Heritage Foundation's Index of Economic Freedom are perhaps the most well known.
Utilising these tools, researchers started to investigate the relationship between economic policies and outcomes for GDP growth, poverty, child labour, life expectancy, literacy, potable water and a host of other development indicators.²
Not surprisingly, these studies moved beyond the anecdotal, showing that higher levels of economic freedom correlate positively to desirable socioeconomic outcomes.
Research into the relationship between the absolute level of economic freedom and investment outcomes yielded a different conclusion, however, showing no correlation.³
In this paper, we share proprietary research findings to show that what affects the investment returns of emerging markets debt (EMD), through changes in cash flow or the discount rate, are government policies that change the level of economic freedom, not the absolute level of economic freedom itself.
There is a paucity of research in this area. We believe our research helps to fill this gap, while also providing insight into Eaton Vance's approach to country research and investing in the EMD asset class.
Methodology. In this study, we analyse hard-currency sovereign bonds of 127 different countries from 2000 to 2016 (Exhibit A). Confirming the earlier work of Roychoudhury and Lawson,⁴ we first show how sovereign spreads and credit ratings correspond to economic policy orientation using the Fraser Institute's Economic Freedom of the World Index dataset.
Second, we present the findings of our regression analysis investigating how significantly economic policy and key macro factors impact sovereign bond ratings, spreads and the frequency of defaults. The results for each variable are ranked by order of impactfulness
25 (2005): 583. ⁴Roychoudhury and Lawson. "Economic freedom and sovereign credit ratings and default risk." Journal of Financial Economic Policy 2, no. 2 (2010): 149-162.
¹Gwartney, Lawson, and Block. Economic freedom of the world, 1975-1995. The Fraser Institute, 1996. ²Gwartney, Hall, and Lawson. Economic freedom of the world: 2018 annual report. The Fraser Institute, 2018. ³Stocker. "Equity returns and economic freedom." Cato Journal. 25 (2005): 583. ⁴Roychoudhury and Lawson. "Economic freedom and sovereign credit ratings and default risk." Journal of Financial Economic Policy 2, no. 2 (2010): 149-162.
Important Additional Information and Disclosures
Source of all data: Eaton Vance, as at 6 September 2019, unless otherwise specified.
This material is presented for informational and illustrative purposes only. This material should not be construed as investment advice, a recommendation to purchase or sell specific securities, or to adopt any particular investment strategy; it has been prepared on the basis of publicly available information, internally developed data and other third-party sources believed to be reliable. However, no assurances are provided regarding the reliability of such information and Eaton Vance has not sought to independently verify information taken from public and third-party sources. Investment views, opinions, and/or analysis expressed constitute judgments as of the date of this material and are subject to change at any time without notice. Different views may be expressed based on different investment styles, objectives, opinions or philosophies. This material may contain statements that are not historical facts, referred to as forward-looking statements. Future results may differ significantly from those stated in forward-looking statements, depending on factors such as changes in securities or financial markets or general economic conditions. This material is for the benefit of persons whom Eaton Vance reasonably believes it is permitted to communicate to and should not be forwarded to any other person without the consent of Eaton Vance. It is not addressed to any other person and may not be used by them for any purpose whatsoever. It expresses no views as to the suitability of the investments described herein to the individual circumstances of any recipient or otherwise. It is the responsibility of every person reading this document to satisfy himself as to the full observance of the laws of any relevant country, including obtaining any governmental or other consent which may be required or observing any other formality which needs to be observed in that country. Unless otherwise stated, returns and market values contained herein are presented in US dollars. In the United Kingdom, this material is issued by Eaton Vance Management (International) Limited ("EVMI"), 125 Old Broad Street, London, EC2N 1AR, UK, and is authorised and regulated by the Financial Conduct Authority. EVMI markets the services of the following strategic affiliates: Parametric Portfolio Associates® LLC ("PPA"), an investment advisor registered with the SEC. Hexavest Inc. ("Hexavest") is an investment advisor based in Montreal, Canada and registered with the SEC in the United States, and has a strategic partnership with Eaton Vance, and Calvert Research and Management ("CRM") is an investment advisor registered with the SEC. This material is issued by EVMI and is for Professional Clients/Accredited Investors only. This material does not constitute an offer to sell or the solicitation of an offer to buy any services referred to expressly or impliedly in the material in the People's Republic of China (excluding Hong Kong, Macau and Taiwan, the "PRC") to any person to whom it is unlawful to make the offer or solicitation in the PRC. The material may not be provided, sold, distributed or delivered, or provided or sold or distributed or delivered to any person for forwarding or resale or redelivery, in any such case directly or indirectly, in the People's Republic of China (the PRC, excluding Hong Kong, Macau and Taiwan) in contravention of any applicable laws. Eaton Vance Asia Pacific Ltd. is a company incorporated in the Cayman Islands with its Japan branch registered as a financial instruments business operator in Japan (Registration Number: Director General of the Kanto Local Finance Bureau (Kinsho) No. 3068) and conducting the Investment Advisory and Agency Business as defined in Article 28(3) of the Financial Instruments and Exchange Act (as amended) ("FIEA"). Eaton Vance Asia Pacific Ltd. is acting as an intermediary to promote asset management capabilities of Eaton Vance Management (International) Limited and other Eaton Vance group affiliates to registered financial instruments business operators conducting the Investment Management Business, as defined in the FIEA. Eaton Vance Asia Pacific Ltd. is a member of JIAA Japan with registration number 01202838. In Singapore, Eaton Vance Management International (Asia) Pte. Ltd. ("EVMIA") holds a Capital Markets Licence under the Securities and Futures Act of Singapore ("SFA") to conduct, among others, fund management, is an exempt Financial Adviser pursuant to the Financial Adviser Act Section 23(1)(d) and is regulated by the Monetary Authority of Singapore ("MAS"). Eaton Vance Management, Eaton Vance Management (International) Limited and Parametric Portfolio Associates® LLC holds an exemption under Paragraph 9, 3rd Schedule to the SFA in Singapore to conduct fund management activities under an arrangement with EVMIA and subject to certain conditions. None of the other Eaton Vance group entities or affiliates holds any licences, approvals or authorisations in Singapore to conduct any regulated or licensable activities and nothing in this material shall constitute or be construed as these entities or affiliates holding themselves out to be licensed, approved, authorised or regulated in Singapore, or offering or marketing their services or products. In Australia, EVMI is exempt from the requirement to hold an Australian financial services license under the Corporations Act in respect of the provision of financial services to wholesale clients as defined in the Corporations Act 2001 (Cth) and as per the ASIC Corporations (Repeal and Transitional) Instrument 2016/396. EVMI is registered as a Discretionary Investment Manager in South Korea pursuant to Article 18 of Financial Investment Services and Capital Markets Act of South Korea. EVMI utilises a third-party organisation in the Middle East, Wise Capital (Middle East) Limited ("Wise Capital"), to promote the investment capabilities of Eaton Vance to institutional investors. For these services, Wise Capital is paid a fee based upon the assets that Eaton Vance provides investment advice to following these introductions. In Germany, Eaton Vance Management (International) Limited, Deutschland ("EVMID") is a branch office of EVMI. EVMID has been approved as a branch of EVMI by BaFin. Mutual Funds are distributed by Eaton Vance Distributors, Inc. ("EVD"). Two International Place, Boston, MA 02110, (800) 225-6265. Member FINRA/ SIPC. Eaton Vance Investment Counsel. Two International Place, Boston, MA 02110. Eaton Vance Investment Counsel is a wholly-owned subsidiary of EVC and is registered with the SEC as an investment adviser under the Advisers Act.
