Why invest in emerging market debt
Emerging market debt as an asset class has grown rapidly in recent years, increasing in breadth and depth. As a result, there is more sophistication in the types of fixed-income products to choose from. At the same time, regulatory and legal changes in many emerging countries have improved the solidity of investments in EM debt. In our view, a blended emerging market fixed-income portfolio combining local currency and hard currency debt is an appealing choice for investors.
- Economic activity in emerging markets benefited from synchronized global growth in 2017, a factor that is likely to persist in 2018.
- Accelerated international trade is likely to boost investment in emerging economies, in particular in Asia and emerging Europe, which are also boosted by a solid economic performance in the eurozone.
- Current economic fundamentals in emerging markets look more solid than they used to.
- Investors appear to be shrugging off political uncertainties.
- Our approach to managing emerging market debt includes the use of ESG selection criteria.
Few concerns over US economic policy
Historically, higher US interest rates have been bad news for emerging market assets, bonds in particular, as they cause financial flows to change course. Higher rates imply a higher return on US government bonds – Treasuries – thus luring investors away from emerging debt and triggering a fall in emerging currencies. The US Federal Reserve’s currently cautious approach to normalizing its monetary policy, with just three rate rises in 2017 and the prospect of a gradual pace in 2018 as well, has so far prevented a steep rise in long US bond yields. Meanwhile, the US dollar has continued to decline in early 2018. As a result, any pressure on emerging market assets has been elusive.
Emerging economies are faring better
Emerging markets benefited from factors such as the upturn in international trade and industrial output in the second half of 2017, while the fundamentals traditionally considered in assessing the health of emerging economies such as the trade balance and international reserves have improved in recent years. We believe this has helped lessen the vulnerability of emerging economies to financial shocks, in particular that of their currencies.
Meanwhile, weak global inflation, currency strength and credible monetary policies have led to a clear slowdown in inflation in emerging economies – from 5.8% in 2012 to 4.2% in 2017 (according to the IMF). This has allowed many central banks to lower their key rates. In Brazil, the key policy rate has been at an historic low of 7% since December 2017; in India, it has been at 6% since August 2017, which is an almost-seven-year low.
This more virtuous economic context (where idiosyncratic risks remain) has allowed investors to shrug off the spikes in political uncertainty that marked 2017, particularly in Venezuela, South Africa and Brazil.
Overall, we believe that economically, many emerging markets are in good shape and that these healthy conditions underpin investments in this asset class.
Based on our analysis of the global economy and the criteria usually used to assess emerging economies, we expect the recent heavy inflows into emerging assets to prove sticky. Against this backdrop, investing in emerging debt can make sense for investors looking to diversify their portfolios and seeking higher yields.
Diversification and additional yields are features of our blended emerging market fixed-income strategy. In addition, the managers strive to incorporate ESG selection criteria, factoring in the increasingly complex environmental, social and governance reality of emerging countries, however without the use of a systematic exclusion policy.
BNP Paribas AM Total Return Fixed Income Fund
Learn more about our emerging markets fixed income mutual fund.
Bryan Carter, CFA, Head of Emerging Markets Fixed Income
Learn more about our EM fixed income strategy and team.